Sticky (economics)

Sticky, in the social sciences and particularly economics, describes a situation in which a variable is resistant to change.^{[citation needed]} Sticky prices are an important part of macroeconomic theory since they may be used to explain why markets might not reach equilibrium right away.^{[citation needed]} Nominal wages are often said to be sticky in the short run.^{[citation needed]} Market forces may reduce the real value of labour in an industry,^{[citation needed]} but wages will tend to remain at previous levels in the short run.^{[citation needed]} This can be due to institutional factors such as price regulations, legal contractual commitments (e.g. office leases and employment contracts), labour unions, human stubbornness, human needs, or self-interest.^{[citation needed]} Stickiness normally applies in one direction. For example, a variable that is "sticky downward" will be reluctant to drop even if conditions dictate that it should. However, in the long run it will drop to equilibrium level.^{[citation needed]}

Economists tend to cite four possible causes of price stickiness: menu costs, money illusion, imperfect information with regards to price changes, and fairness concerns.^{[citation needed]} Robert Hall cites incentive and cost barriers on the part of firms to help explain stickiness in wages.^{[citation needed]}

Examples of stickiness

Many firms, during recessions, lay off workers. Yet many of these same firms are reluctant to begin hiring, even as the economic situation improves. This can result in slow job growth during a recovery. Wages, prices, and employment levels can all be sticky. Normally, a variable oscillates according to changing market conditions, but when stickiness enters the system, oscillations in one direction are favored over the other, and the variable exhibits "creep"-- it gradually moves in one direction or another. This is also called the "ratchet effect". Over time a variable will have ratcheted in one direction.

For example, in the absence of competition, firms rarely lower prices, even when production costs decrease (i.e. supply increases) or demand drops. Instead, when production becomes cheaper, firms take the difference as profit, and when demand decreases they are more likely to hold prices constant, while cutting production, than to lower them. Therefore, prices are sometimes observed to be sticky downward, and the net result is one kind of inflation.

Prices in an oligopoly can often be considered sticky-upward. The kinked demand curve, resulting in elastic price elasticity of demand above the current market clearing price, and inelasticity below it, requires firms to match price reductions by their competitors to maintain market share.

Note: For a general discussion of asymmetric upward- and downward-stickiness with respect to upstream prices see Asymmetric price transmission.

Modeling sticky prices

Economists have tried to model sticky prices in a number of ways. These models can be classified as either time-dependent, where firms change prices with the passage of time and decide to change prices independently of the economic environment, or state-dependent, where firms decide to change prices in response to changes in the economic environment. The differences can be thought of as differences in a two-stage process: In time-dependent models, firms decide to change prices and then evaluate market conditions; In state-dependent models, firms evaluate market conditions and then decide how to respond.

In time-dependent models price changes are staggered exogenously, so a fixed percentage of firms change prices at a given time. There is no selection as to which firms change prices. Two commonly used time-dependent models based on papers by John B. Taylor^[1] and Guillermo Calvo.^[2] In Taylor (1980), firms change prices every nth period. In Calvo (1983), firms change prices at random. In both models the choice of changing prices is independent of the inflation rate.

In state-dependent models the decision to change prices is based on changes in the market and are not related to the passage of time. Most models relate the decision to change prices changes to menu costs. Firms change prices when the benefit of changing a price becomes larger than the menu cost of changing a price. Price changes may be bunched or staggered over time. Prices change faster and monetary shocks are over faster under state dependent than time.^[3] Examples of state-dependent models include the one proposed by Golosov and Lucas and one suggested by Dotsey, King and Wolman.

Significance in macroeconomics

Sticky prices play an important role in Keynesian, macroeconomic theory, especially in new Keynesian thought. Keynesian macroeconomists suggest that markets fail to clear because prices fail to drop to market clearing levels when there is a drop in demand. Economists have also looked at sticky wages as an explanation for why there is unemployment.

References

1. ^ Taylor, John B. (1980), “Aggregate Dynamics and Staggered Contracts,” Journal of Political Economy. 88(1), 1-23.
2. ^ Calvo, Guillermo A. (1983), “Staggered Prices in a Utility-Maximizing Framework,” Journal of Monetary Economics. 12(3), 383-398.
3. ^ Oleksiy Kryvtsov and Peter J. Klenow. "State-Dependent or Time-Dependent Pricing: Does It Matter For Recent U.S. Inflation?" The Quarterly Journal of Economics, MIT Press, vol. 123(3), pages 863-904, August. [1]

• Arrow, Kenneth J.; Hahn, Frank H. (1973). General competitive analysis. Advanced textbooks in economics. 12 (1980 reprint of (1971) San Francisco, CA: Holden-Day, Inc. Mathematical economics texts. 6 ed.). Amsterdam: North-Holland. ISBN 0-444-85497-5. MR439057. 
• Fisher, F. M. (1983). Disequilibrium foundations of equilibrium economics. Econometric Society Monographs (1989 paperback ed.). New York: Cambridge University Press. pp. 248. ISBN 9780521378567. 
• Gale, Douglas (1982). Money: in equilibrium. Cambridge economic handbooks. 2. Cambridge, U.K.: Cambridge University Press. pp. 349. ISBN 9780521289009. 
• Gale, Douglas (1983). Money: in disequilibrium. Cambridge economic handbooks. Cambridge, U.K.: Cambridge University Press. pp. 382. ISBN 9780521269179. 
• Grandmont, Jean-Michel (1985). Money and value: A reconsideration of classical and neoclassical monetary economics. Econometric Society Monographs. 5. Cambridge University Press. pp. 212. ISBN 9780521313643. MR934017. 
• Grandmont, Jean-Michel, ed (1988). Temporary equilibrium: Selected readings. Economic Theory, Econometrics, and Mathematical Economics. Academic Press. pp. 512. ISBN 0122951468, ISBN-13 978-0122951466. MR987252. 
• Herschel I. Grossman, 1987.“monetary disequilibrium and market clearing” in The New Palgrave: A Dictionary of Economics, v. 3, pp. 504-06.
• The New Palgrave Dictionary of Economics, 2008, 2nd Edition. Abstracts:

"monetary overhang" by Holger C. Wolf.

"non-clearing markets in general equilibrium" by Jean-Pascal Bénassy.

"fixprice models" by Joaquim Silvestre. "inflation dynamics" by Timothy Cogley.

"temporary equilibrium" by J.-M. Grandmont.

• Starr, Ross M., ed (1989). General equilibrium models of monetary economies: Studies in the static foundations of monetary theory. Economic theory, econometrics, and mathematical economics. Academic Press. pp. 351. ISBN 0126639701, ISBN 9780126639704. 

External resources

• NBER (2006) "Why Are Prices Sticky? The Dynamics of Wholesale Gasoline Prices."

External links

• Economics A-Z: Sticky Prices