What is Price Rigidity?
Price rigidity is the phenomenon in which prices of goods and services do not adjust immediately or fully to changes in market conditions such as changes in supply or demand. In other words, prices do not fluctuate as much as expected in response to changes in market conditions.
Price rigidity occurs for several reasons. One of the main reasons is the existence of contracts between buyers and sellers that specify prices over a certain period of time. These contracts can be in the form of long-term agreements or simply the expectations of buyers and sellers that prices will remain stable.
Another reason for price rigidity is the existence of implicit agreements or understandings among firms in an industry to maintain stable prices. This can be the result of a desire to avoid price competition, which can lead to lower profits for all firms in the industry.
In addition, businesses may be reluctant to change prices frequently due to the cost of doing so, such as the cost of reprinting price tags or the time and effort involved in communicating price changes to customers.
Finally, consumers may be resistant to price changes and may switch to substitute products if prices change too frequently or dramatically, which can create uncertainty for businesses.
Price rigidity can have both positive and negative effects on the economy, depending on the circumstances. While it can lead to greater price stability and predictability for businesses and consumers, it can also lead to market inefficiencies and slower adjustments to changes in supply and demand.
Reasons Behind the Price Rigidity
Price rigidity can be caused by a variety of factors, including:
- Contracts: Contracts between buyers and sellers that specify prices over a certain period of time can lead to price rigidity. These contracts can be in the form of long-term agreements or simply the expectations of buyers and sellers that prices will remain stable.
- Implicit agreements: The existence of implicit agreements or understandings among firms in an industry to maintain stable prices can also lead to price rigidity. This can be the result of a desire to avoid price competition, which can lead to lower profits for all firms in the industry.
- Transaction costs: Businesses may be reluctant to change prices frequently due to the cost of doing so, such as the cost of reprinting price tags or the time and effort involved in communicating price changes to customers.
- Consumer behavior: Consumers may be resistant to price changes and may switch to substitute products if prices change too frequently or dramatically, which can create uncertainty for businesses.
- Economic conditions: Economic conditions such as recessions or periods of low inflation can also lead to price rigidity as businesses may be hesitant to raise prices during these times.
However, price rigidity is normally found in the Oligopoly market structure because a few large firms dominate the market, these firms tend to maintain stable prices over time, even if there are changes in demand or production costs. This is because they do not want to initiate a price war or provoke retaliation from their competitors.
