Price Stickiness
Candlefocus EditorIn a market economy, it is expected that prices and wages will change to reflect changes in the economic conditions of the time. Prices should rise when the demand for goods and services increases and fall when the demand decreases. Similarly, wages should fall when there is low demand for labour and rise when there is high demand. However, there are instances where prices and wages do not adjust as they should, resulting in a lack of equilibrium in the market.
One reason for price stickiness is known as ‘menu costs.’ When businesses are changing their price list, there are costs involved in doing so. This cost can include republishing and reprinting the price list, changing signs and labels and manually changing the prices on the invoices. Furthermore, businesses may choose to forgo price changes as it could lead to negative reactions from their customers. Additionally, businesses may not want to risk reducing the price too far, leading to an unprofitable sale.
Price stickiness can also be caused by government intervention. Governments may opt to place taxes on goods and services, which could lead to prices remaining higher than the market would normally expect. Similarly, governments can opt to set minimum wages, creating an artificial price floor that is stuck in place.
Beyond the economic implications, price stickiness can have knock on effects on the wider economy. If prices and wages don’t adjust as they should, aggregate demand can remain depressed and unemployment can remain elevated. It can also be a source of inefficiency in the economy, leading to inefficiencies in the production of goods and services.
In summary, price stickiness occurs when prices in a given market do not adjust to changes in economic conditions quickly. The causes of price stickiness can vary, such as ‘menu costs’, government intervention and businesses being afraid to reduce prices too far. Price stickiness can lead to inefficiencies in the market and impacts on the wider economy, such as depressed aggregate demand.