What Are Menu Costs?

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Let me explain menu costs directly: these are the expenses you, as a business owner, face when you decide to change your prices. They're a type of transaction cost, and in New Keynesian economics, they help account for why prices in the economy can be sticky, meaning they don't shift easily even when macroeconomic conditions change.

You should know that menu costs represent the real costs of adjusting prices, and they're central to understanding price-stickiness, a foundational idea in New Keynesian theory. This stickiness means prices don't respond promptly to things like inflation or demand shifts, which can push an economy toward recession. To handle this, I recommend developing a solid pricing strategy to cut down on how often you need to make changes.

When you change the prices you offer customers, you incur menu costs—think of a restaurant printing new menus as the classic case. The core point here is that prices can be sticky; businesses like yours hesitate to adjust until the gap between your current price and the market equilibrium justifies the expense. For instance, you wouldn't reprint menus unless the revenue boost covers that cost, though in reality, pinpointing the exact equilibrium or all costs isn't straightforward.

The idea of menu costs started with economists Eytan Sheshinski and Yoram Weiss in 1977, who showed that in inflation, prices jump in discrete steps rather than rising steadily, only when revenue gains outweigh the fixed costs. New Keynesians expanded this to explain broader price rigidity and its role in economic ups and downs. Gregory Mankiw in 1985 argued small menu costs could have big macroeconomic effects, while George Akerlof and Janet Yellen added that bounded rationality means you might not change prices unless the benefit is significant, leading to inertia in prices and wages that affects output.

In industries with high menu costs, you see price changes happening infrequently, usually only when profit margins drop enough that avoiding the cost hurts more than paying it. The expense varies by firm and tech—reprinting menus, updating lists, or retagging items all add up, and even subtle costs like customer hesitation can play a role. A 1997 study on supermarkets found menu costs averaged over 35% of net margins per store, suggesting this rigidity ripples through supply chains and amplifies industry-wide effects.

Industry Pricing Factors

Menu costs differ by region and industry due to regulations or supplier contracts that might require individual price tags or limit adjustments. Digitally managed inventories make changes cheap with just a few clicks, but generally, high costs mean you update prices only when necessary, often upward. When inputs drop, businesses pocket the margin until competition forces discounts rather than full repricing.

Sticky prices don't react quickly to demand or cost changes—grocery items like canned tomatoes might not drop in price even if raw costs fall, with companies keeping the extra profit. The same goes for restaurants not hiking prices immediately if one ingredient rises. Other examples include haircuts, healthcare, books, and movie tickets, where prices stay put despite shifts.

Menu cost theory looks at how changing prices impacts your business, using the restaurant menu example to show the outlays involved. These costs are unavoidable to some extent because you have to adjust for inflation, but they include everything from printing to potential sales loss from customer hesitancy.

Any expense from changing prices counts—printing, system updates, retagging, or even hiring pricing consultants. Don't forget customer reluctance as a hidden cost.

They often stem from inflation; if your costs for food, rent, or wages rise, you raise prices to maintain profits, but that brings extra expenses like updating menus or websites.

Focus on a strong pricing strategy: analyze your market, see how you stand out from competitors, and set prices that reflect your value. This way, you avoid frequent changes or reductions.

The Bottom Line

In essence, menu costs are what you pay to change prices, from physical updates to market research. High costs slow down adjustments, which can eat into profits, so plan accordingly to keep things efficient.

What Are Menu Costs?

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