An Intuitive Explanation of Rocket and Feather Effects

Abstract

Searching consumers, uncertain about price distribution in a market, will learn about this distribution through prices they observe. Firms will be able to use these learning effects to increase markups. Because the price distribution varies more in times when input costs are volatile, consumers often begin with a weaker prior due to high volatility and will learn more from the price. This volatility effect speeds price increases when costs increase, but slows price decreases when costs decrease. This offers a unique explanation to the empirical puzzle of why prices increase more quickly with cost increases and decrease more slowly with cost decreases.