Menu Costs, Entry Deterrence, and Nominal Rigidity.

This paper studies, in a model of entry deterrence, conditions under which a small cost of changing nominal prices combined with a real rigidity leads to a large nominal rigidity. The entry deterrence environment, which generates the real rigidity, provides an appealing explanation as to why firms sometimes react to shocks by changing output instead of prices. As in Ball and Romer (1990), a large nominal rigidity arises with some parameter values; it is not, however, monotonically increasing as real prices become more rigid. The paper studies, in a model of entry deterrence, conditions under which a small cost of changing nominal prices combined with a real rigidity leads to a large nominal rigidity. The entry deterrence environment, which generates the real rigidity, provides an appealing explanation as to why firms sometimes react to shocks by changing output instead of prices. As in Ball and Romer (1990), a large nominal rigidity arises with some parameter values; it is not, however, monotonically increasing as real prices become more rigid.