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Abstract:

cover
CEP Discussion Paper
Preferences for Fair Prices, Cursed Inferences, and the Nonneutrality of Money
Erik Eyster, Kristof Madarasz and Pascal Michaillat February 2015
Paper No' CEPDP1325:
Full Paper (pdf)

JEL Classification: E03; E10; E31; E40


Tags: nonneutrality of money; fairness; cursedness; markups

This paper explains the nonneutrality of money from two assumptions: (1) consumers dislike paying prices that exceed some fair markup on firms’ marginal costs; and (2) consumers under infer marginal costs from available information. After an increase in money supply, consumers underappreciate the increase in nominal marginal costs and hence partially misattribute higher prices to higher markups; they perceive transactions as less fair, which increases the price elasticity of their demand for goods; firms respond by reducing markups; in equilibrium, output increases. By raising perceived markups, increased money supply inflicts a psychological cost on consumers that can offset the benefit of increased output.