Essays on Price Dynamics
Standard macro models typically assume that producers sell goods directly to final consumers, while, in reality, the distribution network or vertical structure from a manufacturer to a consumer takes various forms. The boundary of firms, or to what extent a firm wishes to extend its distribution or manufacturing process is not a trivial issue when firms develop sourcing strategies. A substantial number of recent studies in international trade have demonstrated systematic patterns in intra-firm trade patterns and price patterns. Inclusion of vertical chains possibly generates frictions by means of double-marginalization problem, asymmetric information and coordination issues, while the choice of vertical structure is an endogenous choice of transaction cost minimization and contractibility.
The first part of work discusses the price patterns by documenting several facts about price rigidity using a large grocery retail data set. The role of retailers has been completely neglected in standard macro pricing models. However, consumers seldom interact with manufacturers directly, especially for grocery items. The assumption that retail level is negligible would be innocuous only if the wholesale price dynamics is similar to retail price dynamics. That is, only when retailers fully pass through the wholesale price to consumers and do not influence the prices that have been set by manufacturers would this assumption make sense. Using detailed information of weekly price and cost from a major retailer store that operates across the United States, we find strong evidence that retail price dynamics are completely different from manufacturer price dynamics. We find two main reasons for why retail prices cannot fully reflect wholesale prices. First, retailers cannot do so because retailers face costs of their own aside from wholesale price. Second, retailers react to variations in demand more directly than wholesalers. Pass-through rate of retailer cost (including wholesale price and extra costs to retailers) to retail price is incomplete. We also find that (1) retail pass-through rate is incomplete, (2) retail pass-through rate and retail price rigidity is negatively correlated, (3) categories with higher retail mark-up show lower pass-through rate, (4) price rigidity is heterogeneous across categories, (5) competition within a category shows positive correlation with pass-through rate, but the correlation is less obvious in the scatter plots and (6) retail price duration is shorter than wholesale price duration, while retail price duration is longer than retail cost duration. In a simple model where retailers play non-neutral role, we can successfully explain the empirical findings, while models with neutral retailers or no retailers fail to explain the findings.
The second part of work discusses the relationship between the vertical structure and the price rigidity. In the job market paper, "Vertical Integration and Retail Pricing Facts for Macroeconomists: Private Label vs. National Brand" (co-authored with Nicholas Li), we propose to extend this analysis to retail behavior and also into closed economy using a data set that contains prices and wholesale costs for a retail chain that operates in the United States. The retailer owns numerous brands that are sold in its stores - ownership in this case implies control over branding, marketing and packaging in all cases and in many cases control over manufacturing as well. We call these private labels and consider equivalent to intra-firm in open macro literature. Beyond generalizing the findings of previous studies to the retail sector and a different data set, the significant growth of store-brands makes the impact of vertical integration in retail on intra and inter-national pricing behavior of independent interest. By analyzing the main dimensions of pricing (duration, cost pass-through and synchronization), we find that the private label goods show shorter price duration, greater cost shock pass-through and greater synchronization of price changes than national brands counterpart. These findings are consistent with previous literature using trade dataset. We compare two existing models that can potentially explain these facts -one featuring symmetric retail demand but different vertical structures/double-marginalization, and the other featuring demand asymmetry and price discrimination as a motive for sales to find evidence that two models are complementary. If vertical structure is endogenous, with vertically integrated lower-priced products gaining market share for product categories, we argue that it can serve as a potential multiplier for demand-based induced changes in retail pricing behavior.
One example that shows retailers' non-neutral role in price-setting mechanism is the existence of sales at retail level. With a recent surge of micro-level data sets from various sources, researchers have been able to examine price dynamics at a disaggregate level and to test previously established macro-pricing models. A notable feature of price dynamics across all of these data sets is significant heterogeneity across products and sectors in measured pass-through and frequency due to temporary discounts, or sales. Previous studies have demonstrated that the retailer is largely responsible for the timing and size of temporary discounts.
Sales prices behave qualitative and quantitatively different from regular prices. Yet, researchers have not reached a conclusion whether or not and how to incorporate intermittent price into crucial issues, such as, macro price-setting models and price index constructions. The core of the question is whether sales have any implications for business cycle and monetary neutrality. The question is also intimately related to how economic agents respond to shocks - how retailers adjust their profit-maximizing strategies, how consumers adjust their consumption patterns in response to cost shocks.
The third chapter of work, "On the Cyclicality of Effective Prices" with Professors Yuriy Gorodnichenko and Olivier Coibin directly tackles this issue. We study the cyclical properties of sales, regular price changes and average prices paid by consumers in a dataset containing prices and quantities sold for numerous retailers across a variety of U.S. metropolitan areas. Both the frequency and size of sales fall when unemployment rates rise and yet the inflation rate of average prices paid by consumers declines with higher unemployment. This discrepancy can be reconciled by consumers reallocating their expenditures across retailers, a feature of the data which we document and quantify. The results point toward a cyclical mis-measurement of inflation which can account for part of the "missing disinflation" during the Great Recession.