Evi Pappa, UC3M

Paper: Pricing Dynamics Under Financial Stress

Abstract: Using 20 years of monthly data on Swedish industrial firms, we estimate short- and medium-run supply elasticities using demand shocks as instruments. The supply curve is upward sloping but flattens during financial stress. In normal times, firms display similar pricing behavior, but under stress, financially constrained firms raise prices and cut inventories, while unconstrained firms lower relative prices and expand market share; both increase sales. A structural model with working capital constraints, inventories, and strategic competition for customer loyalty explains these patterns: when demand rises under stress, constrained firms face tighter liquidity limits, prompting price hikes, inventory reductions that boost short-term sales, and lower investment in loyalty. Unconstrained firms exploit this by cutting prices, yielding the muted aggregate price response observed during financial distress.