On What States do Prices Depend? Answers from Ecuador

This paper argues that differences in the cost structure across sectors play an important role in the decision of firms to adjust their prices. It develops a menu-cost model of pricing in which retail firms intermediate trade between producers and consumers. An important facet of the analysis is that the labour-cost share of retail production differs across goods and services in the consumption basket. For example, the price of gasoline at the retail pump is predicted to adjust more frequently and by more than the price of a haircut due to the high volatility in wholesale gasoline prices relative to the wages of unskilled labour, even when both retailers face a common menu cost. This modelling approach allows accounting for some of the cross-sectional differences observed in the frequency of price adjustments across goods. This paper applies this model to Ecuador to take advantage of inflation variations and the rich panel of monthly retail prices. [Working Paper 22506]