Tuesday, November 9, 2010
Posted by D. Daniel Sokol
Ralph-C Bayer (School of Economics, University of Adelaide) and Changxia Ke (Max Planck Institute) describe Rockets and Feathers in the Laboratory.
ABSTRACT: Consumers often complain that retail prices respond faster to increases in wholesale prices than to decreases. Despite many empirical studies confirming this 'Rockets-and-Feathers' phenomenon for different industries, the mechanism driving it is not well understood. In this paper, we show that, in contrast to the theoretical prediction, asymmetric price adjustment to cost shocks, as well as price dispersion, arises in experimental Diamond (1971) markets. The analysis of individual behavior suggests that the observed price dispersion can be explained by bounded rationality, as our data are well explained by Quantal Response Equilibrium (McKelvey and Palfrey 1995). Asymmetric price adjustment is caused by the updating speed of buyers with adaptive expectations being different after positive and negative cost shocks.