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Economic Quarterly

Fall 1999

Sticky Prices, Marginal Cost, and the Behavior of Inflation

Alexander L. Wolman

In models with sticky prices and monopolistic competition, the cyclical behavior of real marginal cost is a key determinant of firms’ pricing decisions. Necessarily then, such behavior is closely linked to the corresponding cyclical behavior of inflation. Recent empirical work on this link provides support for the models. However, that support is weakened by the implausible assumption of an extreme form of price stickiness. More plausible forms of price stickiness may yet be shown to be consistent with the data but will require revised estimates of the behavior of marginal cost.

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