Question

Provide five (5) reasons why product prices are sticky in the short run.

Answer 1

In view of the claims regarding nominal wage stickiness, the rigidity of other prices is easier to explain. Because wages are a major component of the overall cost of doing business, wage stickiness can lead to stickiness of the production price. Until changing their prices, at least some companies will take a "wait and see" approach with steady nominal wages.

Whereas, in response to changing market conditions, companies may tend to change production and jobs, leaving the price of the product alone. Quantity adjustments have costs, but the associated risks may be considered to be smaller than those associated with price adjustments.

The notion that there are change costs associated with changing prices is another possible explanation for consumer stickiness. In some cases, companies are required to print new price lists and catalogs and report price changes to consumers. Too often, doing this could jeopardize customer relations.

Another source of price stickiness is that businesses may have specific long-term contracts to sell their products at agreed prices to other firms. Electric utilities, for example, often buy their coal or oil supplies under long-term contracts.

Taken together, these explanations for wage and price stickiness explain why aggregate price adjustment may be incomplete in the sense that price level improvement is inadequate to keep real GDP at its potential level. Such explanations do not lead to the conclusion that there is no price adjustment. But it takes some time to make adjustments. The economy may remain above or below its potential output level during this period.