What Is Price Stickiness?
Let me explain to you what price stickiness is—it's the resistance of a market price to change quickly, even when shifts in the broader economy suggest a different price would be optimal.
You know how 'sticky' is a general economics term that applies to any financial variable resistant to change? When we talk about prices, it means sellers or buyers of certain goods are reluctant to alter the price, despite changes in input costs or demand patterns.
Key Takeaways
- Price stickiness is the failure of a market price to change quickly, despite shifts in the broad economy suggesting a different price is optimal.
- When prices cannot adjust immediately to changes in economic conditions, there is an inefficiency or disequilibrium in the market.
- Often the price stickiness operates in just one direction; for instance, prices will rise far more easily than they will fall.
- The concept of price stickiness can also apply to wages.
Understanding Price Stickiness
Price stickiness would occur, for example, if the price of a once-in-demand smartphone stays high at $800 even when demand drops significantly. You can also call it 'nominal rigidity,' and it's related to wage stickiness.
The laws of supply and demand state that quantity demanded falls as price rises, and quantity supplied rises with price, and vice versa. Most goods and services follow these laws, but the adjustment takes time, and for some, it doesn't happen quickly due to price stickiness.
Price stickiness means prices tend to remain constant or adjust slowly, despite changes in production or selling costs. This has important implications for the economy's operations and efficiency.
From a microeconomic view, it can create welfare-reducing effects and deadweight losses similar to government price controls. In macroeconomics, it means changes in money supply affect the real economy, influencing investment, employment, output, and consumption, not just nominal prices.
When prices can't adjust immediately to economic changes or money supply, market inefficiency arises—a disequilibrium persists until prices adjust. This is key in New Keynesian theory, explaining why markets might not reach equilibrium short-term or even long-term.
Price Stickiness Triggers
Price stickiness exists due to forces like the costs of updating pricing, such as changing marketing materials—these are menu costs.
It's also due to imperfect information in markets or irrational decisions by executives. Some firms keep prices constant as a strategy, even if unsustainable based on material, labor, or other costs.
Price stickiness appears in long-term contracts, like a two-year deal to supply office equipment; you're stuck with the agreed price, even if taxes rise or production costs change.
Special Considerations
Stickiness can be in just one direction—if prices move up or down easily but not the opposite. A sticky-up price moves down easily but up only with effort, leading to excess demand when the market-clearing price rises but observed price stays low.
Sticky-down means prices move up easily but resist dropping, causing excess supply when the market-clearing price falls but observed price remains high.
Wage Stickiness
This concept applies to wages too. When sales drop, companies don't cut wages; people get used to their pay and won't accept cuts, so wages are sticky.
John Maynard Keynes argued in 'The General Theory of Employment, Interest and Money' that nominal wages show downward stickiness—workers resist cuts, leading to involuntary unemployment as wages take time to adjust.
From a business angle, laying off less productive employees is often better than across-the-board cuts, which could demotivate everyone, including top performers. Union and civil service contracts contribute to this downward stickiness, like other long-term deals.
What Is Price Stickiness in Oligopoly?
In oligopolies, where a few firms control the market, price stickiness happens because firms hesitate to raise prices for fear of losing share, or lower them to avoid triggering price wars.
What Is Another Word for Price Stickiness?
As I mentioned, 'nominal rigidity' is another term—it refers to the firmness of prices' face value, even when conditions suggest a different optimal price.
Why Is Price Stickiness Bad?
It leads to market inefficiencies. Take a grocery store during supply chain issues—prices rise for produce and goods due to higher costs. If conditions improve, you'd expect prices to fall, but if sticky-down, they stay high, causing inflationary pressures across the economy.
The Bottom Line
Price stickiness is when a market price responds slowly or not at all to economic shifts indicating a better price. It applies to wages too and causes market inefficiencies.
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