Definition
“Price stickiness” refers to the resistance of a price or set of prices to change, despite changes in the broader economy or underlying supply and demand levels. It occurs when prices remain constant or move slowly in response to changes. This can be due to factors such as menu costs, market inconsistencies, or contractual agreements.
Key Takeaways
- Price Stickiness refers to the resistance of a price (or set of prices) to change, despite changes in the broad economy that suggest a different price is optimal.
- Price Stickiness can result in market inefficiencies, as it may prevent supply and demand from meeting at their equilibrium price. This can also lead to periods of excess supply or demand.
- The phenomena often occurs due to menu costs, the cost of changing prices, fear of price wars, and the misinterpretation of price changes by consumers.
Importance
The finance term “Price Stickiness” is crucial as it provides insight into market dynamics and the efficiency of price adjustment to changes in demand and supply.
If prices are “sticky”, they do not respond promptly or entirely to shifts in supply and demand, creating an imbalance in the market and potentially stalling economic activity.
Additionally, price stickiness can lead to inflation or deflation if not properly managed.
Understanding price stickiness is vital for policymakers when designing monetary and fiscal policies.
Furthermore, businesses need to account for price stickiness when determining pricing strategies and forecasting revenues and expenses.
Explanation
Price stickiness, commonly referred to in economic theories, is a phenomenon where the price of a good doesn’t change immediately or readily to the new market conditions. This happens despite a shift in demand and supply that would ordinarily call for an adjustment in price.
This aspect is attributed to the desire of businesses to avoid the cost and confusion associated with frequently changing prices. It is also linked to the psychological aspects of pricing where customers may respond negatively to frequent fluctuations.
The purpose of price stickiness is to maintain price stability in the market, preventing unnecessary or chaotic fluctuations. It helps businesses to set prices strategically and maintain them over a period, making it easier to forecast revenues and earnings.
This factor is highly essential for economic modelling, as many models will lose their predictive powers if prices rapidly adjust to their equilibrium levels. Price stickiness is also commonly used in labor markets where wages tend not to fall even if economic conditions worsen, which can help to maintain long-term contracts and employee morale.
Examples of Price Stickiness
Price stickiness is an economic concept that pertains to the resistance of a price (or set of prices) to change, despite changes in the broad economy that suggest a different price is optimal. Here are three examples:
Menu Costs: Restaurants often display their prices on paper menus, signs, or ads. They might be reluctant to change these prices too often because of the associated printing and indirect costs – this is known as ‘menu costs’. So, they tend to stick with the same prices for a while, even if ingredient costs or overhead have increased.
Contracts and Wages: Many companies have employment contracts with their workers that outline how much they will be paid over a certain period. These wages can be “sticky” because they resist changing frequently due to contractual obligations. Even if the economic situation changes (company profitability or inflation rates), employees’ wages often stay the same until the contract is up for renewal.
Retailer Pricing: If the cost of manufacturing a certain product decreases, many retailers might choose to maintain the selling price of that product to increase their profit margin rather than passing on the cost savings to the consumer. In this case, the price is sticky downwards. Conversely, if manufacturing costs increase, retailers might absorb some of that increase to avoid hiking prices and possibly driving away customers. This is an example of prices being sticky upwards.
FAQs about Price Stickiness
What is Price Stickiness?
Price Stickiness is an economic situation where the price of a good or service is resistant to change despite changes in the market that suggest a different price is optimal. This might be due to contractual arrangements, menu costs, or a variety of other factors.
What are the reasons behind Price Stickiness?
The reasons behind Price Stickiness can be numerous. But the most common reasons include menu costs, fear of price wars, customer relationships, and the presence of implicit contracts.
What are the implications of Price Stickiness?
Price Stickiness has several important implications for economic theory and practice. It can impact the flexibility of the market, affect monetary policy outcomes, and have significant effects on consumer and producer decisions.
How can we measure Price Stickiness?
Price stickiness can be measured in a number of ways. Economists often look at the frequency of price changes in the market, the duration of price spells, or the sensitivity of prices to changes in demand or supply conditions.
What is the relationship between Price Stickiness and Inflation?
Price stickiness can significantly affect the rate of inflation. When prices are sticky, it means they don’t adjust quickly to changes in the economy, such as changes in demand or supply. This delay in price adjustment can create inflationary or deflationary pressures.
Related Entrepreneurship Terms
- Menu Costs
- Nominal Rigidity
- Macroeconomic Stability
- Inflation
- Monetary Policy
Sources for More Information
- Investopedia – This website offers a comprehensive financial dictionary with over 13,000 terms and counting.
- Economics Help – This site offers a wide range of articles covering all aspects of economics including price stickiness.
- National Bureau of Economic Research (NBER) – A private, non-profit, non-partisan organization committed to conduct economic research.
- Khan Academy – Offers instructional videos, practice exercises, and a personalized learning dashboard for more than just school subjects. Also covers a variety of finance and economic topics such as price stickiness.
