What Are Menu Costs?
Menu costs refer to the expenses that businesses face when altering their prices. This phenomenon is deemed a critical aspect of microeconomics and a fundamental explanation for price-stickiness as asserted by New Keynesian economic theories. Price-stickiness can prevent economies from adapting to changing macroeconomic conditions.
Key Insights into Menu Costs
- Menu costs are the expenses associated with a company’s decision to change its prices.
- They provide a key explanation for price-stickiness, an essential principle of New Keynesian economics.
- Sticky prices resist adjustment even amidst macroeconomic fluctuations.
- Failure to adjust prices in tandem with inflation can push economies into recession.
- Companies may reduce menu costs by implementing an astute pricing strategy that minimizes frequent price changes.
Exploring Menu Costs and Their Impact
Menu costs arise from various necessary updates when a business changes its pricing. Take the example of a restaurant needing to reprint menus each time item prices are adjusted. This practical scenario underscores the fixed nature of some costs that remain rigid until significant disparities dictate the change.
For instance, a restaurant should only switch item prices when the expected additional revenue offsets the expense of new menus. Yet, determining the equilibrium market price can be challenging, messy, and inefficient.
Historical Perspective on Menu Costs
Initially introduced by economists Eytan Sheshinski and Yoram Weiss in 1977, the concept underscored that prices surge in recurrent increments, especially within an environment of high inflation. New Keynesian economists later generalized this theory to explain broad nominal price rigidity and its ripple effects across the macroeconomic landscape. The same was championed by Gregory Mankiw in 1985 and extended by George Akerlof and Janet Yellen, who conceptualized price and wage inertia through bounded rationality.
Menu Costs’ Influence Across Industries
Industries experiencing high menu costs generally revise their prices less frequently, opting instead to absorb reduced profit margins rather than incurring additional expenses. The nature and extent of these costs can greatly depend on the firm and technology in use—e.g., updating digital inventories instantly versus manually re-tagging retail merchandise. Additionally, customer hesitation to adopt new prices can silently impact sales.
A 1997 examination showed supermarkets bearing menu costs averaged over 35% of net profit margins. Therefore, businesses considered price updates only when the adjustment markedly rectified profitability concerns, instigating sector-wide price rigidity affecting suppliers and distributors alike.
Sector-Specific Pricing Influences
Menu costs fluctuate with locality and industry regulations, ranging from local mandates for individual item pricing to fluid contractual agreements easing price adjustments. For instance, digital sales platforms benefit from minor menu costs through instantaneous revisions contrasting traditional physical adjustments.
When faced with high menu costs, businesses often delay price adjustments. This outlined rigidity means decreased input costs usually lead to supplementary profit markings until competitive dynamics necessitate true pricing reforms like promotional discounts.
Common Questions About Menu Costs
What Is Menu Cost Theory in Economics?
Menu cost theory studies the impact of price changes on businesses. The classic example involves the financial burden on restaurants to update physical menus when altering prices, translating into broader nominal pricing changes costs.
Which Types of Costs Constitute Menu Costs?
These encompass expenses such as reprinting materials, updating systems, re-tagging goods, consulting for strategy modifications, and gauging consumer purchase hesitancy.
Are Menu Costs Synonymous with Costs of Changing Prices?
Indeed, menu costs signify expenses companies encounter during price changes to remain competitive or in sync with inflationary factors.
Why Do Menu Costs Arise?
Commonly resultant of inflation, e.g., rising commodity or expensing needs compel businesses like restaurants to elevate their charges, incurring added costs for associated updates.
How Can A Business Minimize Menu Costs?
Thorough market, value differentiation and competitor profiling enables a personalized pricing strategy that minimizes frequent updates, aligning products effectively amongst market competition.
Can You Provide an Example of Infrequently Changing Prices?
Certain staples, such as grocery foods or standard consumer services, exhibit sticky prices. Example: retail chains usually don’t lower preserved good prices despite reducing input cost advantages, reflecting steady price norms until critical profits or competition prompts noticeable adjustments.
Related Terms: Price-stickiness, Nominal price rigidity, Bounded rationality, Equilibrium market price.
References
- Sheshinski, E., Weiss, Y. “Inflation and Costs of Price Adjustment”. Review of Economic Studies, Volume 44, Issue 2, June 1977, Pages 287-303.
- Mankiw, N. Gregory. “Small Menu Costs and Large Business Cycles: A Macroneconomic Model of Monopolyx”. * The Quarterly Journal of Economics.* 1985.Accessed June 24, 2021.
- Akerlof, G., Yellen, J. “Can Small Deviations from Rationality Make Significant Differences to Economic Equilibria?”American Economic Review, Volume 75, No. 4, Sept. 1985, Pages 708-720.
- Levy, D., Bergen, M., Dutta, S., Venable, R. “The Magnitude of Menu Costs: Direct Evidence from Large U.S. Supermarket Chains”.The Quarterly Journal of Economics, 12(3), August 1997, Pages 792-825.
