708 TARTERLY JOURNAL OF ECONOMICS ri FIGURE I menu cost, B, which is incurred each time the firm changes its nominal price. 0 This fixed transaction cost results in price sticki ness at the level of the individual firm. Rather than responding smoothly and continuously to changes in the overall price level the firm responds only occasionally, and with discrete price jumps We consider a firm that continuously monitors the price level, and pursues an(s, s) pricing policy, as introduced by Sheshinski and Weiss. The impact of this policy on the dynamics of the firms real price is illustrated in Figure I. The instant the log of the real price r(t)hits the fixed lower limit s, the firm adjusts its nominal price, returning the log of the real price to its upper limit S. Let D= S-s represent the size of the firms price increase. Then, the changes in the firms nominal price within any time period [0, t ]are always an integer multiple of the price range, p(t)-p(0)-k(t)D here k(t)20 is an integer. Noting that ri (0)-p ( o)and using the definition of the firms real price in equation(1), we may formally characterize the(s, S)pricing policy as follows: r (t)E(s, s] and (7)r:(t)-r(0)-(p(t)-p2(0)-(P(t)-P(0) k(t)D-(P(t)-P(0) of menu costs. If dedicated to the production of menus. This is ignored inQUARTERLY JOURNAL OF ECONOMICS menu cost, 0,which is incurred each time the firm changes its nominal price.'' This fixed transaction cost results in price sticki￾ness at the level of the individual firm. Rather than responding smoothly and continuously to changes in the overall price level the firm responds only occasionally, and with discrete price jumps. We consider a firm that continuously monitors the price level, and pursues an (s,S) pricing policy, as introduced by Sheshinski and Weiss. The impact of this policy on the dynamics of the firm's real price is illustrated in Figure I. The instant the log of the real price r(t) hits the fixed lower limit s, the firm adjusts its nominal price, returning the log of the real price to its upper limit S. Let D = S -s represent the size of the firm's price increase. Then, the changes in the firm's nominal price within any time period [O,t] are always an integer multiple of the price range, p (t ) -p(0) = k (t)D, where k(t) r 0 is an integer. Noting that ri(0) = pi(0) and using the definition of the firm's real price in equation (I),we may formally characterize the (s,S) pricing policy as follows: r,(t) E (s,S] and 10. There is an issue here concerning the proper treatment of menu costs. If these are indeed real costs, they should be explicitly included as part of output. Hence a closed model of the economy should properly include a sector of variable size dedicated to the production of menus. This is ignored in our formulation