Information-constrained state-dependent pricing

A model is presented in which decisions about when to review a firm's existing price must be made on the basis of imprecise awareness of current market conditions. Imperfect information is endogenized using a variant of the theory of “rational inattention” proposed by Sims [1998. Stickiness. Carnegie-Rochester Conference Series on Public Policy 49, 317–356; 2003. Implications of rational inattention. Journal of Monetary Economics 50, 665–690; 2006. Rational inattention: a research agenda. Unpublished, Princeton University]. The resulting class of models includes the standard (full-information) “Ss” model as a limiting case, but statistics on individual price changes from micro data sets are better fit by a parameterization with substantial information costs. This can reconcile substantial real effects of nominal disturbances with evidence on the frequency of price changes.