Pricing under Fairness Concerns

Erik Eyster, Kristof Madarasz, Pascal Michaillat
December 2018
https://doi.org/10.5281/zenodo.1954233  (to cite this version)
https://doi.org/10.5281/zenodo.1954232  (to cite all versions)
abstract: This paper proposes a theory of pricing consistent with two well-documented patterns: customers care about fairness, and firms take these concerns into account when they set prices. The theory assumes that customers find a price unfair when it carries a high markup over cost, and that customers dislike unfair prices. Since markups are not observable, customers must extract them from prices. The theory assumes that customers infer less than rationally: when a price rises after an increase in marginal cost, customers partially misattribute the higher price to a higher markup--which they find unfair. Firms anticipate this response and trim their price increases, which reduces the passthrough of marginal costs into prices below one: prices are somewhat rigid. Embedded in a New Keynesian model--as a replacement of Calvo pricing—our theory produces monetary nonneutrality. When monetary policy loosens and inflation rises, customers misperceive markups as higher and feel unfairly treated; firms mitigate the perceived unfairness of prices by reducing their markups, which in general equilibrium leads to higher output.