What is Price Stickiness
Price Stickiness is the resistance of a price (or set of prices) to change, despite changes in the broad economy that suggest a different price is optimal. "Sticky" is a general economics term that can apply to any financial variable that is resistant to change. When applied to prices, it means that the prices charged for certain goods are reluctant to change despite changes in input cost or demand patterns.
Price Stickiness can also be referred to as "nominal rigidity" or "wage stickiness."
BREAKING DOWN Price Stickiness
The laws of supply and demand holds that demand for a good falls as the price rises, as well prices rise when demand increases, and vice versa. Either way, most goods and services are expected to respond to the laws of demand and supply. However, with certain goods and services, this does not always happen due to price stickiness.
Price stickiness, or sticky prices, refers to the tendency of prices to remain constant or to adjust slowly despite changes in the cost of producing and selling the goods or services. This stickiness means that changes in the money supply have an impact on the real economy, inducing changes in investment, employment, output and consumption. When prices cannot adjust immediately to changes in economic conditions or in the aggregate price level, there is an inefficiency in the market, that is, a market disequilibrium. The presence of price stickiness is an important part of macroeconomic theory since it can explain why markets might not reach equilibrium in the short run or even, possibly, the long run.
Price stickiness can occur in just one direction if prices move up or down with little resistance, but not easily in the opposite direction. A price is said to be sticky-up if it can move down rather easily but will only move up with pronounced effort. When the market-clearing price rises, the price remains artificially lower than the new market-clearing level, resulting in excess demand or scarcity. Sticky-down refers to the tendency of a price to move up easily but prove quite resistant to moving down. Therefore, when the market-clearing price drops, the price remains artificially higher than the new market-clearing level, resulting in excess supply or a surplus.
The concept of price stickiness can also apply to wages. When sales fall in a company, the company doesn’t resort to cutting wages. As a person becomes accustomed to earning a certain wage, he or she is not normally willing to take a pay cut, hence, wages tend to be sticky. In his book The General Theory of Employment, Interest and Money, John Maynard Keynes argued that nominal wages display downward stickiness, in the sense that workers are reluctant to accept cuts in nominal wages. This can lead to involuntary unemployment as it takes time for wages to adjust to equilibrium.
The fact that price stickiness exists can be attributed to several different forces, such as the costs to update pricing, including changes to marketing materials that must be made when prices do change. Part of price stickiness is also attributed to imperfect information in the markets, or irrational decision-making by company executives. Some firms will try to keep prices constant as a business strategy, even though it is not sustainable based on costs of material, labor, etc.
Price stickiness also exists in situations were a long-term contract is involved. A company that has a two-year contract to supply office equipment to another business is stuck to the agreed price for the duration of the contract even though the government raises taxes or production costs change.