Price Rigidity

Definition

Price rigidity refers to the phenomenon where prices remain stable or do not change easily in response to shifts in demand or supply. This occurs commonly in certain market structures, particularly oligopoly and monopolistic competition, where firms may avoid changing prices to maintain customer loyalty or avoid price wars. As a result, price rigidity can lead to inefficiencies and prolonged periods of excess supply or demand in the market.

5 Must Know Facts For Your Next Test

1. In oligopolistic markets, firms often prefer to keep prices stable to avoid triggering competitive price cuts from rivals, leading to price rigidity.
2. Price rigidity can result in market inefficiencies, such as excess supply when prices do not adjust downwards during a downturn in demand.
3. Firms in monopolistic competition may experience price rigidity due to brand loyalty, as customers may resist switching to competitors even if prices rise.
4. The presence of menu costs, which are the costs associated with changing prices, can contribute to price rigidity by discouraging firms from frequently adjusting their pricing.
5. Price rigidity can lead to economic phenomena such as stagflation, where high inflation coexists with stagnant economic growth due to slow price adjustments.

Review Questions

• How does price rigidity affect the behavior of firms in an oligopolistic market?
  • In an oligopolistic market, price rigidity leads firms to avoid changing their prices frequently. This behavior stems from the fear of initiating a price war or losing customers to competitors if they raise their prices. As a result, firms may engage in non-price competition through advertising or product differentiation instead of altering prices, creating a more stable but potentially inefficient market dynamic.
• Discuss how the concept of price rigidity relates to consumer behavior in monopolistic competition.
  • In monopolistic competition, price rigidity influences consumer behavior significantly. When firms set prices and maintain them despite changes in demand, customers may develop brand loyalty towards certain products. This means that even if prices increase, consumers might still choose to purchase these products because they perceive them as unique or superior compared to alternatives. This dynamic allows firms to maintain higher prices without losing significant sales volume.
• Evaluate the implications of price rigidity on overall economic stability and efficiency.
  • Price rigidity can have significant implications for economic stability and efficiency by preventing markets from clearing. When prices do not adjust promptly to changes in demand or supply, it can lead to persistent surpluses or shortages. This misalignment can hinder optimal resource allocation and prolong economic downturns. Moreover, when combined with other factors like rigid wages and costs, it can contribute to broader economic issues such as inflation without growth, complicating monetary policy responses.

Related terms

Oligopoly:

A market structure characterized by a small number of firms that dominate the market, often leading to collusion or strategic pricing behaviors.

Monopolistic Competition:

A market structure where many firms sell products that are similar but not identical, allowing for some degree of price-setting power.

Kinked Demand Curve: A model used to explain price rigidity in an oligopoly, suggesting that firms face a demand curve that is more elastic for price increases than for price decreases.