A state-dependent model of intermediate goods pricing

Recent analyses of transaction-level data sets have generated new stylized facts on price setting and greatly influenced the empirical open- and closed-economy macroeconomics literatures. This work has uncovered marked heterogeneity in price stickiness, demonstrated that even non-zero price changes do not fully "pass through" exchange rate shocks, and offered evidence of synchronization in the timing of price changes. Further, intrafirm prices have been shown to differ from arm's length prices in each of these characteristics. This paper develops a state-dependent model of price setting by strategic intermediate goods producers that anticipate and respond to their competitors' actions. The model, which allows for both arm's length and intrafirm transactions, is able to generate all of these empirical pricing patterns. (C) 2011 Elsevier B.V. All rights reserved.