Price Rigidity and Flexibility: Recent Theoretical Developments

Daniel Levy, Bar-Ilan University

Abstract. The price system, the adjustment of prices to changes in market conditions, is the primary mechanism by which markets function and by which the three most basic questions get answered: what to produce, how much to produce and for whom to produce. To the behaviour of price and price system, therefore, have fundamental implications for many key issues in microeconomics and industrial organization, as well as in macroeconomics and monetary economics. In microeconomics, managerial economics, and industrial organization, economists focus on the price system efficiency. In macroeconomics and monetary economics, economists focus on the extent to which nominal prices fail to adjust to changes in market conditions. Nominal price rigidities play particularly important role in modern monetary economics and in the conduct of monetary policy because of their ability to explain short-run monetary non-neutrality. The behaviour of prices, and in particular the extent of their rigidity and flexibility, therefore, is of central importance in economics.

JEL Codes: D21, D40, E12, E31, E50, E52, E58, L11, L16, M20, M30

Keywords: Price Rigidity, Price Flexibility, Cost of Price Adjustment, Menu Cost, Managerial and Customer Cost of Price Adjustment, New Keynesian Economics, Price System