Information and Barometric Prices: An Explanation for Price Stickiness

Price stickiness plays a decisive role in many macroeconomic models, yet why prices are sticky remains a puzzle. We develop a microeconomic model in which two competing firms are free to set prices, but face uncertainty about the state of demand. With some probability, there is a positive demand shock, which is observed but by one firm. In equilibrium, only the informed firm adjusts its price after the shock, while the uninformed firm raises its price only with a delay, after observing the price of its competitor. Hence, prices are sticky in the sense that one firm's price does not adjust immediately. Further, if getting information is costly, the model implies that the larger firm tends to be better informed and to adjust its price first.