Prices: Flexible vs. Sticky

Flexible Prices

Flexible prices are those that easily adapt to changes in market conditions, enabling markets to quickly achieve equilibrium.

Sticky Prices

Sticky prices are those that do not adjust quickly in response to market changes. This can happen for several reasons, including menu costs—expenses associated with changing prices, such as updating labels, price lists, or the fear of negative reactions from consumers. Additionally, many prices are fixed by contracts that take time to expire or renegotiate, delaying price adjustments.

Short Term vs. Long Term

In macroeconomics, for the study of short-term economic fluctuations, it is assumed that some prices are sticky. This assumption is more plausible in the short run, given that many prices are fixed at a certain level. As a result, most economists agree that assuming sticky prices is more accurate for studying the short term, while assuming flexible prices is better for the long-term analysis. In the medium term, the speed at which prices adjust becomes increasingly important.

Models that illustrate how the market clears, or how it reaches equilibrium, assume that prices adjust quickly to bring the market to equilibrium. However, the assumption that the market continuously clears is not realistic because, for this to happen, prices would need to adjust continuously to changes in supply and demand. In reality, many prices are sticky and adjust slowly. The rigidity of prices does not render the assumption of continuous market clearing useless, since prices are not fixed forever—they eventually change. These models indicate the price toward which the economy gravitates. This is why most economists agree that assuming flexible prices in the long run and sticky prices in the short run is the most valid approach.