Strategic Shoppers and Price Dynamics

National Bureau Of Economic Research Inc, Cambridge MA

Investigators

Abstract

Economists have struggled with the question of whether and how to incorporate intermittent price discounts, or ``sales'', into models of price setting and into price index construction. Since episodic sales occur quite frequently in some sectors, price series that ignore sale prices display infrequent price changes, while price series that contain sales prices display very frequent price changes. Ignoring sales, prices tend to look sticky. Including them, prices tend to look flexible. Because of this, there is a brewing debate among macroeconomists regarding whether to consider sales when measuring price levels and price flexibility. These observations suggest that the measurement of inflation, which has numerous public policy ramifications, can be sensitive to the treatment of sales. Furthermore, the effects of monetary policy depend importantly on the extent to which prices are flexible. Understanding how to interpret frequent temporary sales can thus improve our knowledge of monetary policy effects. This project uses a a variant of a standard model form industrial organization in which sales are a price discrimination tool. The prediction of the model and the supporting empirical evidence generated using both price and quantity data challenges the view that sales can be ignored as the majority of transactions in some of the product categories studied take place at sale prices. The project also demonstrates the usefulness of a construct of the "best" price in tracking the prices that consumers actually pay across goods in a category. The project also demonstrates that this hypothetical "best price" facilitates construction of appropriate price measures where quantity data is unavailable. A significant contribution of this project is to compare the substitution patterns found in the data to those implied by the BLS's price index construction methodology. The evidence suggests that the BLS assumptions about consumer behavior may be incorrect for some categories of goods. The project seeks to expand the above results in several ways. First, the project seeks to embed the microeconomic model into a model of monetary transmission. Second, the project seeks to empirically examine the ways in which prices - including the frequency and depth of sales - respond to macroeconomic shocks. The project also addresses the relationship between consumer demographics and their propensity to buy at the "best" price, and examines how these factors change over the business cycle. Both the consolidation of the retailing sector over the last decades and the rapid decline in IT costs suggest that retailer usage of data-driven price discrimination schemes is likely to continue to expand. Thus, price measurement methodologies and estimates of monetary transmission that don't take these schemes into account are likely to become less, rather than more, accurate in the future. The project explores several avenues for marrying these very microeconomics-motivated retailing strategies into an understanding of macroeconomic dynamics.