The Formation of Permanent Price and The Effects on Equilibrium Supply and Price
Erenburg, Sharon Jeanne
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https://hdl.handle.net/2142/70772
Description
Title
The Formation of Permanent Price and The Effects on Equilibrium Supply and Price
Author(s)
Erenburg, Sharon Jeanne
Issue Date
1986
Department of Study
Economics
Discipline
Economics
Degree Granting Institution
University of Illinois at Urbana-Champaign
Degree Name
Ph.D.
Degree Level
Dissertation
Keyword(s)
Economics, General
Abstract
Quantity supplied of a commodity or service is frequently modeled as a function of price and expected price, and data on observed expected price suggest that divergent price expectations exist.
In this thesis, quantity supplied in each market is a function of expected permanent movements in price. These permanent changes in price are not equivalent to total changes in price. Consequently, when making output decisions, agents who are assumed to know both current and historic prices must infer the permanent portion of these prices. Price expectations diverge because suppliers in different markets have different views about the expected movements in the price of their own good due to an inability to distinguish immediately between the permanent and transitory movements in price.
These movements in price are investigated by decomposing the expected price into two separate parts, a permanent component that is expected to persist into the future, and a transitory component that is not expected to persist. The inference of the permanent portion of price is made on the basis of the historical ratio of permanent to total variation of price. The smaller the ratio of permanent to total variance of price for a specific sector, the greater degree of uncertainty in interpreting price movements that sector will face. This greater uncertainty or risk leads to a smaller output response. Consequently, quantity responses should be more moderate in sectors characterized by large price variability.
According to dynamic theory, optimal decision rules vary systematically with changes in the structure of series relevant to decision makers. It follows that changes in policy (or other exogenous changes) will systematically alter the structure and the behavioral relationships of the series being forecast by decision makers.
In order to examine the hypothesis that higher price variability is likely to result in lower real output, due to the risk or uncertainty in forecasting this variability, and to investigate structural change, the model incorporates the use of the Kalman Filter and a time-varying coefficient estimation technique that captures the variation of the adjustment coefficient on price over time.
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