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Price-Setting With Unobservable Elasticities Of Demand: The Business-Cycle Effects Of Heterogeneous Expectations

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  • Jensen, Christian

Abstract

In a dynamic stochastic general equilibrium model with monopolistic competition and flexible prices, we assume that producers must estimate their demand elasticities, which leads to heterogeneous expectations because of idiosyncratic shocks. I argue that these expectations shape firms' perceptions of relative prices, market shares, and individual demand elasticities, thereby distorting their price-setting and production. This model concludes that discarding the conventional assumption of known and exogenous demand elasticity generates business cycle fluctuations indistinguishable from those produced by traditional productivity shocks.

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  • Jensen, Christian, 2016. "Price-Setting With Unobservable Elasticities Of Demand: The Business-Cycle Effects Of Heterogeneous Expectations," Macroeconomic Dynamics, Cambridge University Press, vol. 20(4), pages 1101-1125, June.
    • Handle: RePEc:cup:macdyn:v:20:y:2016:i:04:p:1101-1125_00
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