Dynamic modelling of domestic prices with time-varying elasticities and rational expectations

Abstract

The paper analyses the price on domestic market for an aggregate commodity produced by Norwegian private mainland economy. The long-run solution is modelled assuming imperfect competition. The elasticities with respect to unit labour costs and competing prices vary with an indicator for competitive strength in domestic market. I consider two models for the dynamic part of the equation. Model A is a conditional ECM in current and lagged variables. Model B is derived from a multiperiod quadratic loss function which introduces rational expectations to the model. The backwardforward restrictions are not rejected. The estimated elasticities for both models are in line with the previous empirical results for the Norwegian economy. Model A is preferred to Model B, partly on the basis of informal encompassing results.