Discussion paper
DP18884 Behavioral Sticky Prices
We study a model where households make decisions according to a dual process framework widely used in cognitive psychology. System 1 uses effortless heuristics but is susceptible to biases and errors. System 2 uses mental effort to make more accurate decisions. Through their pricing behavior, monopolistic producers can influence whether households deploy Systems 1 or 2. The strategic use of this influence creates a new source of price inertia and provides a natural explanation for the ”rockets and feathers” phenomenon: prices rise quickly when costs increase but fall slowly when costs fall. Our model implies that price stability is not optimal.
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