Rockets and Feathers in the Laboratory

39 Pages Posted: 28 Sep 2011 Last revised: 31 Oct 2011

See all articles by Ralph C. Bayer

Ralph C. Bayer

University of Adelaide

Changxia Ke

Lingnan (University) College, Sun Yat-sen University

Date Written: September 2011

Abstract

Consumers often complain that retail prices respond faster to increases in wholesale prices than to decreases. Despite many empirical studies confirming this "Rockets-and-Feathers" phenomenon for different industries, the mechanism driving it is not well understood. In this paper, we show that, in contrast to the theoretical prediction, asymmetric price adjustment to cost shocks, as well as price dispersion, arises in experimental Diamond (1971) markets. The analysis of individual behavior suggests that the observed price dispersion can be explained by bounded rationality, as our data are well explained by Quantal Response Equilibrium (McKelvey and Palfrey 1995). Asymmetric price adjustment is caused by the buyers with adaptive expectation updating differently quickly after positive and negative shocks.

Keywords: Asymmetric Price Adjustment, Search Cost, Price Dispersion, Bounded Rationality, Quantal Response Equilibrium

JEL Classification: D82, D83, C91, L13

Suggested Citation

Bayer, Ralph C. and Ke, Changxia, Rockets and Feathers in the Laboratory (September 2011). Working Paper of the Max Planck Institute for Tax Law and Public Finance No. 2011-10, Available at SSRN: https://ssrn.com/abstract=1934760 or http://dx.doi.org/10.2139/ssrn.1934760

Ralph C. Bayer (Contact Author)

University of Adelaide ( email )

No 233 North Terrace, School of Commerce
Adelaide, South Australia 5005
Australia

Changxia Ke

Lingnan (University) College, Sun Yat-sen University ( email )

135 Xingang Xi Road
Guangzhou, Guangdong 510275
China

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