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What is Price Stickiness?

Level:
A-Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 6 Jan 2023

Price stickiness refers to the tendency of prices to be resistant to change, especially in response to changes in demand or cost conditions.

What can cause price stickiness?

Prices may be sticky for a variety of reasons, including the presence of long-term contracts, the cost of adjusting prices, and the expectations of consumers and firms.

Price stickiness can lead to persistent discrepancies between the prices of goods and services and the underlying economic conditions, such as the level of supply and demand or the level of inflation. This can have important implications for the functioning of markets and the transmission of economic shocks.

The concept of price stickiness is central to some macroeconomic models, which assume that prices are slow to adjust in order to explain certain economic phenomena, such as the persistence of unemployment during recessions.

Price stickiness and Keynesian economics

In Keynesian economics, price stickiness is seen as one of the key factors that can contribute to economic instability and the failure of markets to reach a state of equilibrium.

According to Keynesian theory, prices and wages may be slow to adjust to changes in macroeconomic conditions, such as an increase in aggregate demand for goods and services. If prices do not increase in response to higher demand, firms may not be able to increase their production, leading to shortages and potentially causing demand to outstrip supply.

On the other hand, if prices do not decrease in response to lower demand during an economic recession, firms may not be able to reduce their production quickly enough, leading to excess supply and potentially causing demand to fall short of supply.

This can lead to persistent imbalances in the economy and contribute to the occurrence of recessions and other economic downturns.

Price stickiness and oligopoly

In an oligopoly, a market structure characterized by a small number of firms that are able to influence the market price, price stickiness may be more pronounced due to the strategic interactions between firms. In an oligopoly, firms may be hesitant to change their prices for fear of triggering a price war or losing market share to their rivals. As a result, prices may be slow to adjust to changes in demand or cost conditions, leading to price stickiness.

Price stickiness in an oligopoly may also be influenced by the presence of barriers to entry, such as high fixed costs or patents, which can limit the ability of new firms to enter the market and compete on price. This can give incumbent firms more pricing power and make them less likely to engage in price competition.

The kinked demand curve model is often used to explain price stickiness in an oligopoly. This model suggests that firms in an oligopoly will not respond to changes in their rivals' prices in a uniform way, leading to a kink, or bend, in the demand curve at the existing market price. The kinked demand curve model is used to explain the stability of prices in oligopoly markets and the reluctance of firms to engage in price competition.

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