Description
Abstract: We develop a model in which households make decisions using a dual-process framework. System 1 relies on fast, intuitive heuristics but is prone to error, while System 2 demands cognitive effort but yields more accurate decisions. Monopolistic firms can influence which system households engage through pricing. This strategic influence creates a novel source of price inertia. The model accounts for the “rockets and feathers” phenomenon (prices rise quickly but fall slowly), explains why firms with unexpectedly high demand often avoid price changes, and why hazard functions are downward sloping. Our model implies that price stability is not optimal.