Question

3 main reasons for sticky prices under New Keynesian Economics     

Answer 1

Three main reasons for sticky prices udner New Keynesia Economics -

1 ) One of the primary reasons for the stickiness in prices are menu costs. It refers to the additional cost the company has to bear in order to communicate the adjustment in prices to its customers. Consider the example of a restaurant whose costs have now increased. If it were to change prices immediately in the short run, it will have to reprint its menu to reflect the new prices, which would cost more. This is why firms try to avoid changing prices in the short run leading to sticky prices.

2) One of the other reasons for sticky prices in the market is the lack of coordination amongst the market players. Most of the firms do not want to be the first one to change their prices. They fear that if they do it first and their competitors do not follow, they will lose out on market share. This also leads to sticky prices in the short run.

3) One of the other major reasons for price stickiness amongst firms is because of long term contracts with their customers. Many firms get themselves involved in long term contracts with their customers specifying the price or range of price at which they will be selling. This legally binds them to sell at those specified prices, leading to price stickiness.