Menu Costs and Firm Size: Evidence from Consumer Packaged Goods

I explore the magnitude and heterogeneous effects of menu costs on pricing dynamics. To do so, I develop a dynamic discrete choice model of a firm facing menu costs when adjusting prices, using methods from industrial organization. I obtain descriptive evidence that is consistent with the model using scanner data from grocery stores in the US. I then estimate the model and find that the menu cost is substantial, amounting to 7.2% of overall retail profit at the average-sized retailer. When applied to a high-inflation scenario, the model generates an increase in both frequency and magnitude of price changes. In addition, as the menu cost varies little with the retailers’ size, smaller retailers face a higher burden of the menu costs. Being unable to adjust prices frequently, they exhibit earlier and more pronounced responses to anticipated cost increases.

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