Menu cost

Menu Cost

The term Menu Cost refers to the expenses incurred by firms when they change their prices. This concept is derived from the metaphorical cost of a restaurant changing its menu prices, hence the term "Menu Cost". The concept is a key component in New Keynesian Economics, which emphasizes the importance of nominal rigidities in the economy.

Overview

Menu costs are a type of transaction cost and can include both tangible and intangible aspects. Tangible costs include the physical act of changing price tags or menus, while intangible costs can include the time and effort spent on deciding new prices, informing customers, and dealing with potential customer dissatisfaction.

Impact on Price Stickiness

Menu costs contribute to what economists call "price stickiness" - the resistance of a price to change despite changes in the market. When menu costs are high, prices tend to be sticky because firms find it more profitable to maintain current prices rather than incur the costs of changing them. This can lead to a slower adjustment of prices in the economy to changes in supply and demand, which can in turn lead to economic inefficiencies.

Role in Economic Theory

In economic theory, menu costs are used to explain why prices might not always adjust to their equilibrium levels. This is a departure from classical economic theory, which assumes that prices are always flexible and adjust instantly to changes in the market. The concept of menu costs helps to explain why this might not always be the case in the real world.

Menu Costs and Inflation

Menu costs are also related to the concept of inflation. When inflation is high, the real value of money decreases over time, which can lead to more frequent price changes and thus higher menu costs. This can create a vicious cycle, as higher menu costs can in turn contribute to higher inflation.

See Also

• New Keynesian Economics
• Transaction cost
• Price stickiness
• Inflation

References

• Mankiw, N. G. (1985). Small Menu Costs and Large Business Cycles: A Macroeconomic Model of Monopoly. The Quarterly Journal of Economics, 100(2), 529-537.
• Ball, L., & Romer, D. (1990). Real Rigidities and the Non-Neutrality of Money. Review of Economic Studies, 57(2), 183-203.