Modeling variations in price inertia under demand uncertainty

Abstract

This study employed a model of two-period in which the manufacturer determines a price floor and drafts output of production precedently to the attainment of certainty by demand. In addition, the closer the distance between the minimum price and the price during the high phase of demand, the higher is the degree of price inertia. This model first assumes that the manufacturer sells products to consumers directly and then introduces competing retailers who have the right to return unsold goods at the minimum resale price specified by the manufacturer. By solving for the minimum resale price and production output, the model’s results indicate that vertical market linkages influence the market power–price inertia relation and that asymmetric price transmission could be symbolic of competitive markets. Further, study reveals that the retail price in a highly concentrated retail market might be lower than that in a retail market with fierce competition. In addition, high product durability, low demand uncertainty, low return credit, and long contract duration between upstream and downstream members lead to price inertia rising during economic recessions compared with booms. The relationship between price adjustments and market competition, therefore, suggests that the reasons underlying price inertia should be considered when formulating antitrust and monetary policy.