Search, Sticky Prices, and Inflation

Abstract

This paper examines equilibrium in a market with free entry where consumers search and firms set prices on individual units of the commodity. The prices attached to newly produced goods are continuously adjusted. Prices attached to previously produced goods can only be changed at a cost. Thus inflation reduces the real price of goods in inventory awaiting sale. The presence of previously priced goods lowers the reservation price of customers. Thus, inflation cuts into the market power created by the need to search for the good. Consumer welfare is inverse u-shaped in inflation with a strictly positive optimal inflation rate.