Search, Costly Price Adjustment and the Frequency of Price Changes - Theory and Evidence

Abstract

We establish a new empirical finding that the intensity of search for the best price affects the frequency of nominal price changes. This relationship holds in very different economies and for various proxies for search intensity. We derive this relationship from a model of monopolistically competitive firms that face menu costs of changing nominal prices and heterogeneous consumers who search for the best price. We discuss alternative explanations and argue that they do not explain the observed correlations. Our results establish that pricing policies differ endogenously in the cross-section. This may be an important feature missing in many macroeconomic models based on nominal rigidities with exogenous frequency of price changes.Nominal rigidity; search; price adjustment