Price stickiness, also known as sticky prices, denotes the resistance of market prices to quick adjustments despite shifts in the broader economy. This phenomenon impacts the efficiency of markets and has implications for both micro and macroeconomics. Price stickiness extends beyond goods and services and can also apply to wage adjustments. It creates inefficiencies when prices fail to adapt promptly to changes in economic conditions, leading to market disequilibrium. Understanding its triggers and impacts is crucial in comprehending market behavior and economic theories.
Understanding price stickiness
The principles of price adjustment
Price stickiness, or sticky prices, refers to the sluggish response of prices to changes in the costs associated with producing and selling goods or services. While the laws of supply and demand predicate that prices fluctuate in response to market changes, price adjustments often occur slowly, causing markets to operate inefficiently.
Implications of price stickiness
From a microeconomic perspective, price stickiness can lead to welfare-reducing effects and deadweight losses similar to those imposed by government-mandated price controls. In a macroeconomic context, it influences the real economy, affecting investment, employment, output, and consumption. The presence of price stickiness is an essential element in New Keynesian macroeconomic theory, explaining why markets may not attain equilibrium in the short or even long run.
Price stickiness triggers
Menu costs and imperfect information
Several factors contribute to price stickiness. Menu costs, such as the expenses associated with updating pricing and marketing materials, impede swift price adjustments. Imperfect information within markets or irrational decision-making by businesses also contributes to this phenomenon.
Price stickiness is evident in scenarios involving long-term contracts. Companies adhering to extended contracts maintain agreed prices despite changing conditions, such as government policy shifts or alterations in production costs.
Sticky-up and sticky-down prices
Price stickiness can manifest in one direction, either with resistance to price decreases (sticky-up) or to price increases (sticky-down). When market-clearing prices imply a change, observed prices might resist adjustment, leading to either excess demand or excess supply.
Similar to price stickiness, wages can also be resistant to adjustments. Workers are typically reluctant to accept wage cuts, resulting in downward wage stickiness. This phenomenon, observed by John Maynard Keynes, contributes to involuntary unemployment and affects business decisions concerning workforce adjustments.
Here are the pros and cons of price stickiness:
- Market stability in certain conditions
- Protection against abrupt economic fluctuations
- Can preserve employment levels in downturns
- Can cause inefficiencies and deadweight losses
- May hinder optimal resource allocation
- Could contribute to prolonged market disequilibrium
Frequently asked questions
What is price stickiness?
Price stickiness refers to the resistance of market prices to change quickly, despite shifts in the economy suggesting an optimal change in price.
What causes price stickiness?
Price stickiness can be triggered by various factors, including menu costs, imperfect information, and long-term contracts that lock prices.
How does price stickiness affect the economy?
Price stickiness can lead to market inefficiencies, impacting both micro and macroeconomic conditions and potentially leading to market disequilibrium.
- Price stickiness resists quick price changes despite economic shifts.
- It impacts market efficiency at micro and macroeconomic levels.
- Wage stickiness, a related concept, affects employment and market equilibrium.
- Triggers of price stickiness include menu costs and long-term contracts.
View article sources
- Sticky Prices – Federal Reserve Bank of New York
- Some Evidence on the Importance of Sticky Prices – The University of Chicago
- Sticky Prices: An Empirical Assessment of Alternative Models – Boston College
- Sticky Wage Theory Explained: Impact on Employment, Inflation, and Economic Trends – SuperMoney