MACRO: Pricing Inequality; Simon Mongey (Federal Reserve Bank of Minneapolis)

Abstract

This paper studies household inequality and product market power in general equilibrium. Heterogeneous households face the standard income fluctuations problem and have idiosyncratic preferences over a continuum of goods. Heterogeneous firms produce these varieties and set their price as oligopolistic competitors given the endogenous distribution of demand. We show how households’ savings motives and incomplete insurance endogenously lead to variation in household-level price elasticities with wealth and income, and that this is consistent with recent empirical evidence. In the stationary equilibrium, firms’ market power varies as households with different price-sensitivities differentially select into high- and low-price varieties by wealth and income. Under standard preferences, high quality firms sell high marginal cost goods at higher prices to richer households, endogenously face less elastic demand, and set higher markups. Quantitatively, we show that a one-time fiscal transfer to households leads to a medium run decline in TFP due to two effects (i) poor households trade up to higher marginal cost goods, (ii) these goods’ markups increase as poor households’ demand becomes less elastic.

Click here to view paper.