Price Stickiness

Price stickiness is a real-world scenario where once inflated; the price does not fall back to optimal levels. Even in optimal conditions, the price sticks to the inflated range. Such markets do not comply with the law of supply and demand. 

Price Stickiness is also referred to as sticky prices. Inflation, shortage or lack of supply, and economic shift play a key role in increasing the price of a particular product. The sticky wage theory was introduced by John Maynard Keyes.

• Price stickiness refers to the market tendency where price remains constant after hikes—it does not fall back to optimal levels.
• The stagnation of price hikes could be brought out by lack of competition, monopoly, shortage of goods, unavailability of similar products, consumer choice, lack of options, or consumer needs.
• The sticky wage theory highlights how wages grow very slowly—even in scenarios of inflation and unemployment.
• Though wages increase slowly, employees keep working. This is due to inflation, personal liabilities, lack of income sources, and unemployment.

Price stickiness refers to scenarios where markets don’t comply with the law of supply and demand. Theoretically, when demand declines and supply increases, economists expect a fall in price. But in real-world scenarios, markets do not always follow the demand-supply theory.

Prices have a tendency of remaining constant or declining very slowly—price stickiness. This could be due to lack of competition, monopoly, shortage of goods, unavailability of similar products, consumer choice, lack of options, or consumer need.

In many markets, when the price of a commodity rises due to certain factors, it shifts to a higher price range. But, very often, the price does not fall back, even after resolving underlying issues. Instead, the price stagnates, sticks to the higher range, and does not return to optimal levels.

In such market scenarios, products become unreasonably overpriced—triggering permanent inflation in the market. Sticky prices remain constant irrespective of supply, demand, or the availability of certain goods.

Let us look at some examples to better understand the practical application of this concept.

Example #1

In 2015, sticky prices were deepening inflation in India. However, some people believed that it would self-adjust. Outside intervention was not seen as necessary. 

Sticky prices are very real; they can quickly trigger an onslaught of recession. Many economists argue against the law of supply and demand—they highlight the flaw in the price mechanism. Price may lack self-regulation. They do not always adjust back to optimal levels.

Contemporarily, economists advocate governmental or external intervention to deal with sticky price scenarios. For regulating the cost of goods and services, the concerned authority must take timely action. Central banks use the sticky-price model. Flexible price models are not used anymore.

Example #2

Let us assume there is a local market where tomato is sold at the retail price of $1 per pound. Suddenly, farmers stop harvesting and go on a protest. The protest was brought out by soaring inflation and the government turning a blind eye to farmer rights.

The protest causes an acute shortage of tomato supply. Tomatoes are now sold at an inflated price of $3 per pound. Within three weeks, the government agrees to the farmers’ demands. Normalcy resumes, farmers harvest tomatoes, and supply levels rise to normal. Despite all that, the price of tomatoes sticks to $3 per pound.

This tendency of price is called sticky prices or price stickiness. What was once sold at $1 per pound, established itself as a commodity that costs $3 per pound. In time, the price can decline. But usually, price declines are slow—permanent inflation is triggered in most instances.  

Following are the salient features of wage and price stickiness:

• John Maynard Keynes introduced the wage and price stickiness concept. He calls it ‘nominal rigidity. ‘
• The sticky wage theory postulates that even in scenarios of inflation and unemployment, wages grow very slowly.
• It occurs because employee wages are "sticky down" and cannot decline even in severe economic conditions. Employees or laborers will resist or fight a cut in their salaries.
• The hypothesis states that organizations tend to look at other business areas to cuts costs in sticky wage scenarios.
• The theory declares that even if the employee wages are expected to go upwards, it happens at a nominal rate. Even when remuneration increases slowly, employees keep working due to inflation, personal liabilities, lack of income sources, and unemployment.

This has been a guide to Price Stickiness & its meaning. We discuss price stickiness strategy, wage stickiness theory, and product pricing using examples. You may also have a look at the following articles –

• Price Transparency
• Wage-Price Spiral
• Price Controls