Price Stickiness

Published Oct 25, 2023

Definition of Price Stickiness

Price stickiness, also known as sticky prices, refers to a situation in which prices do not adjust immediately to changes in supply and demand. Instead, prices remain fixed or change only gradually over time, even when there are changes in the underlying economic conditions.

Example

Let’s take the example of the housing market. Imagine a housing market where there is an increase in demand due to low-interest rates and a growing population. In a perfectly flexible market, the increase in demand would cause prices to rise, signaling to builders that there is a shortage of housing and motivating them to increase supply. However, in a market with price stickiness, prices do not adjust immediately.

So, when demand increases, the prices in the housing market remain relatively stable for some time. Builders may be hesitant to increase supply because they are unsure if the increased demand is sustainable or just temporary. As a result, there is a temporary shortage of housing in the market, causing potential buyers to compete for the available housing, driving up prices.

Eventually, price adjustments occur, but they are delayed compared to a perfectly flexible market. This delay in price adjustments is a characteristic of price stickiness.

Why Price Stickiness Matters

Price stickiness has important implications for the economy as it affects market dynamics and can lead to market inefficiencies. When prices are sticky, markets may not clear efficiently, leading to imbalances between supply and demand. This can result in temporary shortages or surpluses, leading to inefficient resource allocation.

Price stickiness also impacts monetary policy and central banks’ ability to manage inflation. Inflation may persist for a longer time if prices are sticky, making it harder for central banks to control price stability through interest rate adjustments.

Understanding price stickiness is crucial for policymakers, economists, and businesses as it helps them predict and analyze the behavior of markets and the economy as a whole.