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Price setting, imperfect information, and the law of one price

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  • Daniel, Betty C.

Abstract

This paper uses a two-country model to investigate the effects of price-setting behavior, with menu costs, imperfect information, and flexible exchange rates, on deviations from the law of one price. When last minute price revision is costly, and when the variances of real and nominal disturbances are similar such that the information content of financial variables is low, then firms might choose not to adjust domestic currency and foreign currency prices to signals from observable financial variables. When a subset of prices adjusts, the most likely candidates are export prices. However, the adjustment will fall short of that needed for the law of one price.

Suggested Citation

  • Daniel, Betty C., 1992. "Price setting, imperfect information, and the law of one price," Journal of Macroeconomics, Elsevier, vol. 14(3), pages 383-415.
    • Handle: RePEc:eee:jmacro:v:14:y:1992:i:3:p:383-415
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