>>> But this is the puzzle for neoclassical economics. If
> you don't drop your price when costs fall, why don't I
> drop mine to sell more quantity? And then you must
> drop yours to compete. That's what the model predicts.
>
> jks
I think that the correct explanation for this problem is the (perhaps Post-) Keynesian one; the decision to cut prices in response to falling costs is not symmetrical with the decision to raise prices in response to rising costs, when one takes into account uncertainty and time.
Consider the immediate financial impact of a price rise versus a price cut. Unless you are in an unusual market or dealing in an unusual good, the immediate effect of a price rise is higher revenue, while the immediate impact of a price cut is lower revenue. Even if you expect the lower revenue to be compensated by lower costs, you have to finance the transition to lower prices (known in the business school literature as "margin investment in market share"). There is no such period of lower revenues in anticipation of lower costs when you raise prices; that actually gives you an upfront positive cashflow.
So, the point is that cutting prices is an investment decision that needs to be financed while raising them is not. The fundamental asymmetry here suggests that you will raise prices any time you think it is, on balance, the best thing to do, while you will only cut prices when you are sure that you have to.
dd
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