Heterogeneity in pricing behavior in hybrid DSGE-ABM macrodynamics

Abstract

Evidence demonstrates that pricing behavior is persistently heterogeneous across firms. We explore hybrid dynamic stochastic general equilibrium (DSGE)-agent-based modeling (ABM) macrodynamics in which firms periodically revise (and possibly switch) pricing strategies. Firms choose a pricing heuristic from a set of alternatives encompassing a cost-based heuristic with a standard markup, a cost-based heuristic with a quality-adjusted markup, and a heuristic of following competitors’ pricing behavior. For illustration, we employ a simulated method of moments to calibrate the model with quarterly data for the United States. The model qualitatively replicates several empirical facts about firms’ strategic pricing behavior, particularly with respect to the frequency and magnitude of price adjustments. Two key findings are price stickiness and persistent heterogeneity in pricing behavior, with no single pricing rule becoming dominant. A local sensitivity analysis was conducted on selected key micro-level and macro-level parameters, with results indicating that price stickiness and persistent heterogeneity in firms’ pricing behavior are driven by a combination of both micro- and macroeconomic factors. Embedding some tenets of the ABM approach such as introducing heterogeneous firms evolutionarily learning and adapting to the environment into the DSGE model enables us to qualitatively reproduce the persistent heterogeneity in pricing behavior across firms without compromising its ability to reproduce several stylized macroeconomic facts. A key broad policy implication is that the microdiversity and macrodynamics of the economy are inherently co-evolutionary phenomena.