MONOPOLY POWER AND DOWNWARD PRICE RIGIDITY UNDER COSTLY PRICE ADJUSTMENT

ABSTRACT A method of ‘backward deduction’ is used to analyse the decisions of a firm, setting price and quantity before demand observations are made, with the option to adjust price at a cost after demand is observed. It is shown for such a firm that the events of (1) downward price rigidity; (2) overproduction; and (3) a high degree of monopoly power are closely related. The paper distinguishes itself from the previous literature on costly price adjustment in its treatment of disequilibrium situations and focus on monopoly power in relation to price rigidity. The main results are obtained for a linear demand curve and a uniform demand distribution.