What Is Price Stickiness?
Price stickiness, or sticky prices, is the resistance of market price(s) to change quickly, despite shifts in the broad economy suggesting 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 sellers (or buyers) of certain goods are reluctant to change the price, despite changes in input cost or demand patterns.
Price stickiness would occur, for instance, if the price of a once-in-demand smartphone remains high at say $800 even when demand drops significantly. Price stickiness can also be referred to as "nominal rigidity" and is related to wage stickiness.
- Price stickiness, or sticky prices, is the failure of market price(s) 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 or in the aggregate price level, 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. When sales fall, the company doesn’t resort to cutting wages.
Understanding Price Stickiness
The laws of supply and demand hold that quantity demanded for a good falls as the price rises, and the quantity supplied rises when prices rise, and vice versa. Most goods and services are expected to respond to the laws of demand and supply. However, this adjustment process takes time and, with certain goods and services, does not always happen very quickly 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 can have a number of important implications for the operations and efficiency of the economy.
For example, from a microeconomic perspective, price stickiness can induce the same welfare-reducing effects and deadweight losses as government-imposed price controls. In a macroeconomic context, it may mean that changes in the money supply have an impact on the real economy, inducing changes in investment, employment, output, and consumption, rather than just nominal price levels.
When prices cannot adjust immediately to changes in economic conditions or in the supply of money, there is an inefficiency in the market—that is, a market disequilibrium exists as long as prices fail to adjust. The presence of price stickiness is an important part of New Keynesian macroeconomic theory since it can explain why markets might not reach equilibrium in the short run or even, possibly, in the long run.
Price Stickiness Triggers
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. These are known as menu costs.
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 appears in situations where 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 if relevant conditions change, such as the government raising taxes or production costs changing.
Stickiness in Just One Direction
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 implied by new circumstances rises, the observed market 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 implied market-clearing price drops, the observed market 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, they are not normally willing to take a pay cut, and so 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.
From a business perspective, it is often preferable to layoff less productive employees rather than cut pay across the board, which could demotivate all workers, including those that are most productive. Union and civil service wage contracts may also strongly contribute to downward stickiness of wages in the same way as other types of long-term contracts.