What are Sticky Prices? A Guide to Price Stickiness

In this article, we will talk about sticky prices. "Sticky" in this case means resistant to changes in supply and demand, general market trends, or inflation. That is, sticky prices for goods practically do not change, regardless of conditions.

Below, we will analyze in more detail how sticky prices can arise, how to get rid of stucky price, and also compare flexible and sticky price.

Price stickiness is a phenomenon in which, despite market changes, the price of a product remains unchanged or changes very slowly.

It goes without saying that the supply and demand rule should apply to all market prices. When demand falls, the price falls, and when demand increases, the price increases. This allows the market to function successfully. When prices respond to demand in a timely manner, an equilibrium price is reached.

But rigid prices can upset this balance of supply along with demand. If the price of a product fails to adapt to market conditions in time, this will entail consequences for the efficiency of the economy.

On the scale of a single company, rigidity of prices can cause financial losses and stagnation of goods in stock. On a macroeconomic scale, price imbalances can cause losses of investments, problems with output and consumption of products, and employment issues.

Rigid prices make the market inefficient due to non-equilibrium. The faster price adjustment happens and prices adapt to changes in the market, the more efficient the market gets.

Price stickiness, or the resistance of prices to change in response to shifts in supply and demand, plays a critical role in economic theory and practical market strategies. This phenomenon, characterized by sticky prices, impacts both the macroeconomic landscape and individual business operations. In macroeconomics, price stickiness interacts with money supply, aggregate demand, and expected inflation, influencing the Federal Reserve System's decisions on interest rates to manage economic stability. Sticky prices can slow the adjustment process to economic shocks, necessitating more deliberate interventions to steer aggregate price levels towards equilibrium.

From a business perspective, understanding the dynamics of stickiness aids in formulating pricing strategies that navigate the challenges of menu costs and the balance between flexible and sticky price models. For instance, firms might opt for stickiness price to maintain customer loyalty and predictability in revenue streams, even when facing fluctuations in demand and supply. This approach, however, requires careful management of price regulating strategies to avoid the adverse effects of excess demand or supply, which can lead to lost sales or surplus inventory.

Moreover, the concept of wage and stickiness, especially in the context of sticky wage theory, highlights how nominal rigidity in wages can parallel price behaviors, affecting overall economic performance. Businesses and policymakers alike must account for the implications of sickness on the broader economic indicators, such as the aggregate supply curve and relative prices, to ensure that pricing strategies and monetary policies align with the goals of economic stability and growth. In oligopoly markets, where price competition is fierce yet prices remain constant due to strategic price setting, understanding and leveraging price stickiness can provide a competitive edge, allowing firms to navigate market structure changes and adapt to changing prices without incurring significant menu costs or disrupting established market positions.

There are several reasons why sticky prices may occur:

- The cost of repricing goods. This situation is unlikely in e-commerce, however, as price adjustment can occur quite often; still, you should be prepared for this factor.

- Misinformation about the market: for example, unreliable sources or poor collection and analysis of information.

- Irrational decisions of company managers. Some firms will try to keep prices constant as a business strategy, even though it is not sustainable based on costs of material, labor, etc.

Price stickiness is of significant importance in both economics and business for several reasons. In the macroeconomic context, sticky prices can influence the overall stability and responsiveness of the economy to changes in monetary policy. When prices do not adjust quickly to shifts in money supply or aggregate demand, it can lead to inefficiencies in the allocation of resources and distortions in the aggregate supply curve. This sluggish price adjustment can affect the effectiveness of fiscal and monetary policies aimed at controlling inflation and stabilizing economic growth. For businesses, understanding stickiness is crucial for developing effective pricing strategies. Sticky prices can impact a company's ability to react to market changes, potentially leading to lost revenue opportunities or increased inventory costs. Moreover, the phenomenon of price , especially when related to wage and price stickiness and the sticky wage theory, highlights the challenges in adjusting prices and wages downwards even in times of lower demand, thus affecting employment levels and overall economic performance. Recognizing the implications of sticky prices helps firms and policymakers navigate economic shocks and adjust their strategies to maintain competitive advantage and economic stability.

Sticky prices can lead to significant challenges in the face of demand shocks. When prices are slow to adjust to a sudden drop or increase in demand, it can result in either excess supply or excess demand. In scenarios where demand unexpectedly falls, businesses stuck with higher-than-market prices due to price stickiness may face surplus inventory, tying up capital and increasing storage costs. Conversely, if demand suddenly rises, firms unable to quickly increase prices might experience stockouts, missing out on potential revenue and damaging customer satisfaction. This rigidity in price alignment, characterized by sticky prices, exacerbates the impact of economic shocks, making it harder for the market to reach an equilibrium efficiently. The inability to swiftly change prices in response to market conditions underscores the critical nature of stickiness in economic research and highlights the need for businesses to incorporate flexibility in their pricing strategy to mitigate the adverse effects of demand fluctuations on inventory levels and overall financial health.

In 2015, there was a crisis in India due to stickiness price. The state considered it necessary not to interfere. Most believed that the market itself would come to an equilibrium, but it did not happen.

Since then, in similar situations as in India, the state intervenes in pricing policy to prevent a crisis, because equilibrium will not happen by itself.

Imagine the following situation: initially, tomatoes on the market cost $2 per kilogram. But at some point, farmers start to strike because of inflation and working conditions. The strike affects the supply of tomatoes: supply is decreased, and the price of tomatoes rises to $6 per kilogram.

After some time, the government responds to the farmers’ demands and the strikes stop. However, the price remains $6 per kilo. This is also an example of a sticky price. Usually, in such cases the price is either slowly adjusted or does not change at all and is later leveled by inflation.

Price stickiness can occur if a price moves in one direction with little resistance. For example, a price may stick to a higher range if it moves down easily but grows with difficulty. And vice versa: if the price can grow quite confidently, then it is likely that it will stick to the lower range. Therefore, when the implied market-clearing price drops, the observed market price remains artificially higher than the new market-clearing level, resulting in excess supply (surplus).

The concept of stickiness can also apply to wages. When sales fall in a company, the company doesn’t resort to cutting wages. When a person becomes accustomed to earning a certain wage, they are not normally willing to take a pay cut, so wages tend to be sticky and some menu costs change.

Here, we will look at several solutions that will help eliminate the phenomenon of price stickiness.

Knowing your expenses and understanding where they come from is the basis of any enterprise. Structuring your income and expenses allows your business to function successfully. Also, analyzing your expenses will help you to reconsider your pricing strategy if your prices are sticky. It depends on the case, however: perhaps another fixed price strategy will suit you. But in any case, you need to understand which strategy harms your business, and which brings profit.

This concept is related to the previous one. In addition to understanding your income and expenses, you need to have a clear understanding of your business model: before you lower your prices, you need to make sure that this pricing policy won’t harm it.

If you know how much the customer is willing to pay for your product, you will know how much you can raise or lower the price. Obviously, you can’t make such decisions by blindly guessing: your pricing strategy should be based on statistics and data about your customers. Various optimization, scraping and parsing software can help you with this.

An honest dialogue with your customers is the best way to build a pricing strategy. First of all, your prices must be appealing to them: this is the key to a successful trading business.

Choose an equilibrium price based on your customers’ opinions and purchasing power, as well as the general economic situation. These factors can constantly change, so your prices will change too, thereby avoiding stickiness. But, again, it’s not only important to make sure prices don’t stand still; it’s important to change prices carefully and competently.

Flexible prices are the opposite of sticky ones. Thus, the prices are susceptible to a variety of factors and can often rise or fall. Goods with flexible prices include commodities that constantly adjust their prices, such as gasoline, and the broader idea of flexible pricing encompasses some more specific pricing strategies.

For instance, the practice of segmented pricing — like when movie theaters offer discounted prices for seniors and students — falls under the umbrella of flexible pricing. The same goes for a construction contractor being willing to negotiate their prices with clients based on the scale of a job.

A sticky price policy can be successful in rare, specific cases. But on a global scale, prices will still not stand still, at least because of inflation.

We hope that this brief guide to sticky prices was useful for you. Summing up, we can say that a sticky price strategy, no matter whether the manufacturer intentionally or accidentally creates it, in most cases has negative consequences for enterprises.

Now you know how to avoid price stickiness, but we also suggest that, in order to create an effective pricing policy, you may need price optimization software, such as Priceva’s Retail Price Optimization.

Prices are sticky when they do not adapt to market changes or customer purchasing power. The product may either depreciate or become too expensive, which will lead to a decrease in demand: goods will lie idle in the warehouse, and businesses and consumers will both suffer.

It will depend on your particular business. There are two aspects regarding costs: pricing costs (service fees for price optimization, for example) and payment for losses that your business may incur. Setting flexible prices is cheap, since it doesn’t require complex calculations. Still, there is a high probability that this strategy will fail, and then you will have to pay for the losses that your business will incur.

The opposite of sticky prices is flexible prices. Price stickiness is static, and flexible prices are dynamic. These prices are susceptible to several factors such as changes in the market, demand, inflation, and other things that may affect the price of goods.

Over the long run, prices can never be sticky. For example, it’s impossible to resist inflation, not to mention other factors. Therefore, over a period of 10-20 years even the most stickiness price will change.