Price StickinessThe resistance of a product's price to change quickly despite changes in the market condition

In economics, there are these concepts we call supply and demand.

Theoretically, the price of a certain good or service would increase or decrease depending on its supply and demand.

When the supply for the product (good or service) goes up, the price of such a product should go down.

The opposite will happen if the supply goes down.

In contrast, when the demand for the product (good or service) goes up, the price of such a product should go up.

And of course, the opposite will happen if the demand goes down.

To summarize, the price of a product should go down when the supply for it increases and/or the demand for it decreases.

Additionally, the price should go up when the supply for it decreases and/or the demand for it increases.

Well, that’s how it should work in theory. And some real-world products do follow this theory such as gasoline.

However, it doesn’t work like that for some products. The prices of a certain product would stay as is no matter the changes in its demand or supply.

For example, let’s say that there is this in-demand smartphone that sells for $1,000 at the time of its launch.

A year has passed and the demand for this smartphone has decreased.

However, its price still stays at $1,000.

It’s only after 5 years that the price of the smartphone finally decreases.

There’s a term for this resistance of a product’s market price to change quickly: price stickiness (a.k.a. nominal rigidity).

In this article, we will be taking a deeper look at price stickiness.

What does it mean?

What triggers price stickiness?

How does price stickiness affect a business?

Why does it occur?

We’ll try to answer these questions as we go along with the article.

What is Price Stickiness?

Price stickiness (a.k.a. sticky prices, nominal rigidity) refers to the resistance of market price(s) to change quickly even if there’s a change in the market conditions (e.g. demand goes down) or cost of production (e.g. price of a raw material increases).

In economics, “sticky” or “stickiness” is a term that applies to any financial variable that is resistant to change.

When we apply it to the prices of products, it would result in sellers (or buyers) of certain products being reluctant to change prices even if it’s more optimal to do so according to changes in market conditions.

For example, let’s take a look at a typical restaurant, one that has a menu of the meals that they serve.

Let’s say that this restaurant serves meals that have tomatoes in them.

Now, let’s say that the market price of tomatoes has risen.

Do you think the restaurant would increase the prices of its meals because of it?

Probably not, right?

Well, that is unless the increase in the price of tomatoes is so high that it necessitates an increase in menu prices.

But usually, a restaurant wouldn’t change its menu prices just because the prices of its meal ingredients decrease or increase.

Price stickiness doesn’t mean that the price of the product wouldn’t change no matter what.

It would just take a longer time for the price to adjust.

For example, if the changes in the cost of production don’t affect a business’s bottom line that much, it won’t have much reason to change prices.

The presence of price stickiness in a market may indicate that there is inefficiency.

In particular, the market will not reach equilibrium unless adjustments to prices are made.

Certain markets might not reach equilibrium even in the long run because of price stickiness.

Factors that Trigger Price Stickiness

Menu Costs

Menu costs refer to the total cost of updating prices.

This can get expensive very quickly depending on the industry to where the business belongs.

Let’s go back to talking about restaurants.

In the production of its meals, a restaurant will consume raw materials that are typically agricultural products such as meat, tomatoes, potatoes, etc.

The prices of these agricultural products change frequently depending on the supply and demand.

Now imagine having to change the restaurant’s menu every time there’s a change in the prices of agricultural products.

Imagine the time and effort it takes to do such a task. Seems like it’s not worth it, right?

Unless the changes in the prices of agricultural products greatly affect the bottom line of the restaurant, it probably will stick to its current menu prices.

The restaurant would rather take the possible cuts in profits than shoulder the cost of updating its prices.

Imperfect Information

In some markets, information may not always be accurate.

For example, some speculations about market prices increasing may not materialize.

Due to the possibility of inaccurate information, businesses tend to be reluctant in updating their prices.

A change in price might result in lower sales.

Irrational Decision-Making

Price stickiness may also stem from the irrational decision-making of the business’s higher-ups.

They might decide to stick to the business’s current prices even if it can lead to lesser profits.

This could be because they “feel” that the business doesn’t need an update in prices even if the financial data states otherwise.

Customer Reaction

While updating product prices to their optimal levels can result in the maximization of profits, frequent changes in prices can confuse and even annoy customers.

Imagine buying a product yesterday only to find out that its price decreased today.

Wouldn’t that be annoying?

There’s also the issue of competition, where customers might choose to purchase from another business because of prices.

A prominent example of this would be Coca-Cola.

For 70 years, Coca-Cola didn’t update its prices due to the fear of alienating its customers.

And this is despite the fact that the cost of production has only been increasing year by year.

Price Stickiness in Just One Direction

Price stickiness doesn’t always mean the prices wouldn’t change no matter what.

Sometimes, price stickiness occurs in just one direction such as moving up or down with little to no resistance, but not as much in the opposite direction.

It can either be sticky-up or sticky-d0own depending on the direction that the price is resistant to change.

A price is said to be sticky-up if it can move down with little resistance but only moves up if the seller (or buyer) intends to.

On the other hand, a price is said to be sticky-down if it can move up with little resistance but is very resistant to moving down.

This is often the case with wages as wage cuts don’t occur as often as wage increases.

An employee who is accustomed to receiving a particular amount of wages will not like it when his/her pay is reduced.

From a business perspective, laying off unproductive employees is the more preferable course of action rather than enacting pay cuts across the board.

Wage cuts can demoralize employees which can ultimately lead to losses for the business.