Price settings
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Downward sloping demand curve
where
- \(\mu_{py}\) is the monopoly power of the representative producer in its own market, and \({\left.{\mu_{py}}\middle/\left(\mu_{py}-1\right)\right.}\) is the underlying elasticity of substitution of demand for the producer's output (which gives rise to the monopoly power)
Period profits
with the price adjustment costs given by $$ \Xi_{py,t} \equiv \tfrac{1}{2} \, \xi_{py} \, \extern{py}_t \, \extern{y_t}\, \bigl( \Delta \blog py_t - j_t \bigr)^2 $$
where \(j_t\) is a price indexation factor given by
Maximization problem
where
- \(\betay_t\) is an additional discount factor to compensate for the uncertainty of cash flows generated by real economic activity
Optimal price setting with no adjustment cost (steady state) is a markup over the marginal cost
Optimal price setting with adjustment cost is a Phillips curve