Menu cost
A typical example is a restaurant that has to reprint the new menu when it needs to change the prices of its in-store goods.
[6] The concept of the menu cost has originally introduced by Eytan Sheshinski and Yoram Weiss (1977) in their paper looking at the effect of inflation on the frequency of price changes.
Sheshink and Weiss concluded that even fully anticipated inflation results in an actual menu cost for the business.
[7] The idea of applying menu costs as an aspect of Nominal Price Rigidity was simultaneously put forward by several New Keynesian economists in 1985–1986.
In 1985, Gregory Mankiw concluded that even small menu costs create inefficient price adjustment and push equilibrium below the point which is socially optimal.
[8] George Akerlof and Janet Yellen put forward the idea that due to bounded rationality firms will not want to change their price unless the benefit is more than a small amount.
The menu cost idea was also extended to wages as well as prices by Olivier Blanchard and Nobuhiro Kiyotaki.
[13] In 2007, Mikhail Golosov and Robert Lucas found that the size of the menu cost needed to match the micro-data of price adjustment inside an otherwise standard business cycle model is implausibly large to justify the menu-cost argument.
[15] This is a property that markups do not get squeezed by large adjustment in factor prices (such as wages) that could occur in response to the monetary shock.
The company would not engage in price adjustment if profit margins start to fall to the point where menu costs lead to more revenue losses.
[18] A 1997 study published by Harvard College and MIT used data from 5 multistore supermarket chains to investigate the magnitude of menu costs.
The study found that menu costs were 2.5 times higher for the store impacted by the local pricing requirements.
When the idiosyncratic shocks in the model are shut down, the frequency of price adjustments is roughly unchanged in high inflationary environments but it is much reduced when inflation is low.
[19] Daily fluctuations in the economy lead to small shifts in firm structure, supply and demand affecting the profits curve.
However, firms do not in turn adjust their prices constantly as Z acts as a buffer, making such small benefits economically unviable compared to the menu cost.
[17] Note that as Z approaches 0, prices will constantly adjust to match the optimal profit level from the shifting economy as there is no cost to do so.
