Can prices be sticky if they change all the time?

by on January 24, 2013 at 7:21 am in Data Source, Economics | Permalink

Emi Nakamura and Jon Steinsson ask exactly that question:

Figure 2 plots a typical price series for a grocery product in the United States. This figure illustrates a central issue in thinking about price rigidity for consumer prices: Does this product have an essentially flexible price, or is its price highly rigid? On the one hand, the posted price for this product changes quite frequently. There are 117 changes in the posted price in 365 weeks. The posted price thus changes on average more than once a month. On the other hand, there are only 9 regular price changes over a roughly 7 year period. Which of these summary measures of price rigidity is more informative?

Here is their new paper (pdf), which is an excellent survey of what we know about price (as opposed to wage) stickiness.

You will note is that we know more about price stickiness in times of inflation rather than deflation, if only because we have more of the former.  Intuitively, one might expect greater flexibility of prices in the downward direction, for prices that is.  Why are bosses afraid to cut nominal wages?  It will disrupt worker morale and prompt shirking and sabotage.  Why might suppliers be reluctant to raise prices?  They might not wish to upset long-term relationships and expectations with customers.  But customers would love nominal price declines, or so it would seem.

Less-than-fully-flexible nominal prices may follow from sticky nominal wages, to be sure.  But absolutely sticky nominal prices?  The supplier still can cut price by a bit.  By construction of the problem, these are sectors which are not perfectly competitive and thus we are not at P = MC.  If demand goes down, and one of your main costs is sticky, you still can shade price a bit rather than say raising it.  Since “menu costs” appear refuted by the data, small price changes should not be so costly.

Yet, in reality, we don’t actually know much about what happens and why.

DocMerlin January 24, 2013 at 7:38 am

I’ve been saying it for years that economists don’t understand stickyness. It doesn’t come from goods prices, it comes from nominal contracts, debt contracts being by far the stickiest and most unidirectionally sticky.

david January 24, 2013 at 9:08 am

The lit review would seem to disagree with you.

Anonymous January 24, 2013 at 7:46 am

Does anyone know if the Greeks still have inflation once the rising Valued Added Tax is removed?

Tyler Cowen January 24, 2013 at 8:06 am

It’s getting them to fall commensurate with the apparent size of the negative deflationary shock that is the trick.

IVV January 24, 2013 at 9:29 am

What I’m struck with by that graph is that you really see the “low inflation” of the early 1990s in the way that consumers typically understand it, in contrast with the “low inflation” happening now–which doesn’t at all look like low inflation to the consumer at this time.

Michał Gamrot January 24, 2013 at 9:51 am

Does anyone now any good articles/reviews of literature about price stickiness?

Bill January 24, 2013 at 11:36 am

Try this: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=137584

I also disagree with the claim that menu costs (cost of changing prices) is low. First, it depends on the product (ie, not a commodity), but in in-store retailing changing prices costs money. More than you think. Companies that make electronic price signs for instore retailing have done studies on this. Internet retailing is different–there the prices are quite fluid.

Second, price changes within organizations–for drugs, heavy equipment, parts, etc.–are typically done once a year. the costs are not just the costs of talking to the customer (who may in turn have contracts with its customers), but the internal costs of negotiating between sales and marketing and forward contracting for inputs. There is research on this as well, although I don’t know if the authors have published.

Bill January 24, 2013 at 11:47 am

I think the other thing the paper misses is how large retail chains negotiate prices and discounts with large suppliers. A Target or a Walmart will negotiate price and promotion for an entire year on a major consumer product. They may negotiate price protection but only for similar large brands. Price changes for drug pricing, heavy equipment pricing to dealers, and consumer durables that get sold through a distribution chain will also have a long price cycle.

The paper also is missing how in-store pricing works and may be confusing sales with actual prices to retailers.

dearieme January 24, 2013 at 10:01 am

“Can prices be sticky if they change all the time?” By analogy with babies: yes.

h January 24, 2013 at 10:58 am

One application is accommodation prices for rentals where there appears to be some considerable nominal rigidity (documented in Genesove “The Nominal Rigidity of Apartment Rents,”The Review of Economics
and Statistics, Vol. 85, No. 4, 2003, pp. 844-853.. Anecdotally rather than cut prices in downturns, landlords offer other valuable inducements – in NYC this might be paying the broker’s fee, offering a month/two months/three months “free” rent, including a flat screen tv … etc. though rent regulations may be playing a role
I haven’t yet read this linked paper, but I wonder whether in IO markets there are other means to try to maintain a relatively high reference price – more frequent sales say rather than a reduced price? In the IO applications stock-piling and other features might mean there are other implications of such means of affecting the real price without touching the “nominal” price

RM January 24, 2013 at 12:19 pm

I often wonder why it is so difficult to check/confirm prices in Walmart. Frequently, items are mislabeled and one is unsure what is the prices. But it is difficult to find a price scanner. Always annoying and I can’t help but think that the shortage of prices scanners is deliberate. Not exactly on point … but good opportunity to rant.

Pablo January 24, 2013 at 12:22 pm

1. What about the usual assumption that in a competitive setting prices vary according to excess demand (and not many other reasons)? We can see many prices changing but that is no guarantee of equilibrium.
2. And what about Stiglitz suggestion that excess changing prices are a problem for agents to act properly?
It seems to me that prices changing or not is much less important that answering those two questions.

Brian Donohue January 24, 2013 at 12:29 pm

“Yet, in reality, we don’t actually know much about what happens and why.”

I approve of this candor.

Seth January 24, 2013 at 12:34 pm

Just because prices don’t change the way a third party believes they should, doesn’t mean they’re sticky. It seems to me more of knowledge problem than a sticky problem.

Unless you are dealing with fish. Sticky prices on fish can become a stinky problem.

PJ January 24, 2013 at 12:42 pm

I have come to the view that posted prices are sticky in the downward direction for three reasons: 1) Many things are essentially unit demand and price setters believe that only a small fraction of customers will respond to a price cut 2) People get upset when they see a lower price than they paid (Anderson and Simester QJE 2010) 3) Price setters expect nominal shocks to be temporary and don’t want to do a price increase that they expect to reverse in the near future. Price increases are painful to implement if the only reason you give is that “demand went up”. For reasons I don’t fully understand, Wal-Mart insists on a cost based justification for price increases.

Fonzy Shazam January 24, 2013 at 1:42 pm

I like this response and was thinking along these same lines. I find downward stickiness to be just as intuitive as upward stickiness. I would add that sellers may believe that downward movements set up undesirable expectations for buyers. The probable fact that “customers would love nominal price declines” doesn’t seem sufficient to explain that price declines should be easier than price increases. Most all costs associated with price changes are present down as well as up.

Donald Pretari January 24, 2013 at 3:14 pm

That’s why Immediate Reflation seemed a good idea to me. It’s better to fight a battle on Familiar Terrain.

Bill January 24, 2013 at 4:08 pm

Price of Can of Campbell’s Soup at the Grocery Store:

99c marked down to 85c Save 14c
99c marked down to 87c Save 12c
99c 20c off with coupon (redemption rate of 10%)
1.10 but 2 for $2.00

Did you notice that the price went up each period or did you just focus on the 99c and the cent off number?

Price of HP Printer

HP printer without wifi printing $140
Epson printer with wifi printing $160
New announced HP printer now with wifi printing $140

Did you notice that HP and Epson are engaged in a price war with HP not charging for the additional functionality?

How well did the cited paper capture any of this?

brainwarped January 26, 2013 at 12:49 pm

I couldn’t read further than the first page because of the numerous missing assumptions the authors made to come up with those statements. In the quote (“price rigidity for consumer prices”), Cowen reveals what most likely is this paper’s best point (Why Cowen read more than the first page and why the NSF hasn’t asked for their grant money back are mysteries to me). Consumers pay different prices for the same goods much more frequently than previously acknowledged in economic literature. The manufacturers (this goes for Polymath’s comment below as well) have many reasons for selling their products at the price that they agree to, and the retailers have their own reasons as well. The most well-known reason (and apparently one that Cowen does not yet know, as his last sentence above suggests) for prices to decrease is actually quite similar for both the manufacturers and the retailers. They both want to sell more. At the consumer level, this is because the average retailer has small margins, so they can make more money by selling more product. Therefore, they will decrease the price to sell more, and many will even decrease the price below their break-even price.

Now, put yourself in the shoes of a retail business manager/owner. Generally, the more cash you have, the more inventory you can purchase, and the more times you replenish inventory (turns), the more money you make. If your cash is tied up in inventory that isn’t selling, you lower the price to try to sell it faster, converting your inventory into cash that can be used to purchase new or different products for your customers to purchase. For durables, like in groceries, this issue is compounded by the fact that food spoils.

Also, to back up my “below their break-even price” statement, there generally are two good reasons. The first is limited floor space. The second is called a loss-leader. Most brick and mortar retail businesses sell consumers a basket of goods, so the business can still make an immediate profit (opposed to freeing up floor space and cash at a loss to purchase different products that will make up for that in the future).

Maybe Columbia University’s business school (and I guess economics as well) should require their professors to take Business 101:)

Ryan January 24, 2013 at 5:29 pm

Somebody tell me what’s going on with cell phones. Huge demand, right? Huge product selection, right? You can get a subsidy with a 2 year contract. Without a two year contract, you spend more than a mediocre laptop or flat screen TV. Do prices plunge after a new phone spends a year in the market?

Is there a product analog that I haven’t thought of?

Sorry, I’ll do my own homework someday and I’ll reserve the question, “Is the new iPhone really worth $900?” cause an economist once told me never to engage in a discussion of “worth”.

polymath January 25, 2013 at 5:21 pm

How could prices not be sticky? At time t1, I design a computer motherboard, based on the performance and prices of components currently available to me. At time t2, I sign medium-term supply contracts for those components, guaranteeing me a volume and a price. At time t2+1day the “spot” prices of those components change, but for my application the prices don’t change because I’m under contract. At time t2+2days a new microprocessor is introduced that I would have used in the design had it been available at time t1 — and the new microprocessor has different complements (support devices) than the one in the original design. The total cost of the motherboard, had it been designed with the new microprocessor and complements, would have been less than the actual cost at t2 or t2+1day. But it takes time to do a redesign, so those costs aren’t passed through for a while.

I get that those scenarios aren’t in the scope of “sticky commodity prices,” but I don’t understand why not. Sticky wage arguments tend to be based on the fact that there is some implicit agreement that nominal wages won’t go down, and there’s abundant evidence (from the spike of 0% wage changes during the Great Recession) that there is such an implicit agreement. Contracts can make prices not change for a period of time. Design cycle times can make prices not change for a period of time. Why is there so much doubt about sticky wages and prices? Is there some specific property inherent in “stickiness” that ordinary fixed prices don’t have?

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