Question

One of the reasons the short-run aggregate supply curve is upward sloping is because prices are sticky – they don´t adjust as quickly as we might expect. This story from NPR’s Planet Monkey (episode 416) discusses perhaps the stickiest price of all time: the 5-cent Coke. Listen to this podcast and then discuss what kept the price of Coke so steady over such a long period of time and what caused it to eventually change. How do sticky prices slow the adjustment of the macroeconomy? What other prices are sticky? What makes them so? P

Answer 1

It shall be noted that Coke's 5-cent pricing remained in place for more than 70 years (1886 to 1959) despite cost increased to produce Coke.

This was because of various reasons such as:

1) There were cost involved in retrofitting the soda vending machine that accepted only nickel

2) A very large amount of signage was to be replaced

3) Coke entered into bottling contract in 1899 that fixed price of bottles used for packaging purpose

3) Consumers showed tendency to revolt against 100% increase from a nickel to dime

The eventual change in price of Coke beyond 5-cent could change because of following reasons:

1) Vending machine began to reliably make change

2) Coke implemented the strategy of keeping 1 in 9 vending machine empty so that customer could be made to insert 2 nickels to get a bottle of coke

3) 1940s inflationary pressure in US made nickel Coke unsustainable

It shall be noted that sticky prices makes monetary policy to lag in bringing a desired impact on real economy.

When price stickiness exists, the response of change in supply and demand on each other lag behind, resulting in equilibrium to arrive only after a lag.

When money supply is changed and when the price remain sticky & constant or slow in response to change in cost of producing goods and service change, market remain in disequilibrium state.

The other prices that are sticky are as follows:

1) Wage stickiness - Workers are not willing to accept a cut in nominal wage rate. The labor market does not return to equilibrium at faster rate as workers show reluctancy in accepting nominal wage cut. This leads to involuntary unemployment.

2) Fixed price contract

3) Fuel price - Price of petrol and diesel charged to consumer - They are slow to respond to the changes in the price per barrel in international market