Price Stickiness: An Unyielding Market Phenomenon
Price stickiness, or sticky prices, refers to the resistance of market prices to change swiftly, even when broader economic factors suggest that a different price would be optimal. This term can apply to any financial variable resistant to change, but when it comes to pricing, it symbolizes the reluctance of sellers (or buyers) to adjust their prices, despite changes in input costs or demand patterns.
For instance, consider a once-popular smartphone that maintains its high price of $800 even when the demand plummets. This situation illustrates price stickiness, also known as nominal rigidity, and is closely linked to the concept of wage stickiness.
Key Takeaways
- Price stickiness involves market prices failing to quickly adapt to economic shifts suggested by optimal conditions.
- Market inefficiency or disequilibrium arises when prices cannot promptly adjust to changes in economic conditions or overall price levels.
- Prices often rise more easily than they fall, showcasing a one-directional stickiness.
- The concept extends to wages in the market, leading to inefficiencies when wages don’t drop during reduced business activity.
The Mechanics of Price Stickiness
The laws of supply and demand dictate that the quantity demanded of a good decreases as the price increases, and vice versa. Ideally, goods and services should align with these laws, but the adjustment process can be slow, resulting in price stickiness.
Price stickiness indicates the tendency for prices to remain static or shift gradually, even when production and selling costs change. This phenomenon impacts economic operations and efficiency, leading to potential welfare reduction or market inefficiencies similar to those caused by price controls.
At a microeconomic level, the effects of price stickiness mirror those of government price controls, reducing general welfare and causing deadweight losses. From a macroeconomic perspective, the presence of price stickiness signifies that changes in the money supply can affect real economic factors like investment, employment, and consumption, rather than merely nominal price levels.
The Triggers of Price Stickiness
Several forces contribute to price stickiness, such as the costs associated with updating pricing and marketing materials, known as menu costs. Additionally, price stickiness may stem from imperfect market information or irrational decisions by company leaders. Businesses might maintain constant prices as a strategy, even when it’s unsustainable based on evolving costs of materials and labor.
Price stickiness is also observed in long-term contract situations. For example, a company binding itself to a two-year contract for providing office equipment cannot change the contract price despite fluctuations in conditions, such as tax increases or varying production costs.
Stickiness in One Direction
Price stickiness can be uni-directional—when prices either rise quickly with difficulty in falling or vice versa. A price is considered sticky-up if it decreases easily but struggles to increase. Conversely, sticky-down prices increase smoothly but resist declining.
This behavior leads to market disequilibrium as observed prices don’t match shifting market-clearing levels, resulting in either scarcity or surplus.
Wage Stickiness
Wage stickiness is similar to price stickiness, as wages tend to resist downward adjustments even when business incomes fall. Employees are usually unwilling to accept pay cuts given their established earnings, leading to nominal wage rigidity described by John Maynard Keynes. This can cause involuntary unemployment as wages take longer to reach market equilibrium.
From a business angle, it’s more practical to lay off less productive employees rather than slash wages across the organization due to the potential demotivation of the workforce. Furthermore, union contracts and public sector wage agreements frequently reinforce this downward stickiness in wages, mirroring the effects of other long-term contracts.
Related Terms: Market Prices, Demand, Economy, Microeconomics, New Keynesian Economics, Menu Costs, Production Costs.
References
- John Maynard Keynes. “The General Theory of Employment, Interest, and Money”, Page 209. Springer International Publishing, 2018.
