Chapter 25: Problem 12

Explain what economists mean by "menu costs."

Short Answer

Expert verified

In summary, menu costs are the expenses incurred by businesses when they change their prices, arising from activities like reprinting menus, retraining staff, and updating marketing materials. These costs can make firms more hesitant to frequently adjust prices and can contribute to price stickiness at a macroeconomic level. Price stickiness can slow down the price adjustment process, leading to prolonged periods of inefficiencies and misallocation of resources in the economy.

Step by step solution

1. Define Menu Costs

Menu costs refer to the expenses that a business incurs in order to change its prices. This term comes from the example of a restaurant in which changing the prices on the menu requires reprinting and redistributing the menus, which can be expensive and time-consuming.

2. Provide an example

Consider a restaurant that wants to adjust the prices of its dishes due to fluctuations in the cost of ingredients. In order to make this change, the restaurant would need to print new menus and distribute them to all tables, potentially retraining its staff, updating its marketing materials, and communicating these changes to customers. All these activities entail costs, both monetary and opportunity costs, which are collectively referred to as "menu costs."

3. Explain the effects of menu costs on businesses

Menu costs can impact businesses in various ways. Firstly, they act as a barrier to price adjustments, causing firms to be more hesitant to frequently adjust prices in response to changes in demand or input costs. This may result in a temporary misalignment between a firm's prices and its costs or market conditions. Secondly, menu costs may force businesses to plan price changes more strategically, considering the cost of implementing these changes, rather than solely basing the decision on external factors like market demand or input costs. This might result in businesses choosing to adjust their prices only when the expected benefits greatly outweigh the menu costs.

4. Describe the macroeconomic implications of menu costs

On a macroeconomic level, menu costs can contribute to price stickiness, which refers to the resistance of prices to change in the short run. Price stickiness can slow down the price adjustment process in response to changes in inflation, exchange rates, or other economic indicators. As a result, economies may take longer to reach equilibrium or adjust to economic shocks, leading to prolonged periods of inefficiencies, unemployment, and misallocation of resources.

5. Summarize the concept of menu costs

In conclusion, menu costs refer to the expenses that businesses face when adjusting their prices, such as the cost of reprinting menus, retraining staff, and marketing new prices. These costs can have significant implications both for individual firms and for the overall economy, as they contribute to price stickiness and the slow adjustment of markets in response to changes in economic indicators.