Price Setting in Forward-Looking Customer Markets

If consumers form habits in individual goods, firms face a time-inconsistency problem. Low prices in the future help attract customers in the present. Firms, therefore, have an incentive to promise low prices in the future, but price gouge when the future arrives. In this setting, firms benefit from "committing to a sticky price." If consumers have incomplete information about costs and demand, the firm-preferred equilibrium has the firm price at or below a "price cap." The model therefore provides an explanation for the simultaneous existence of a rigid regular price and frequent "sales."