economics Economics () is the social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics anal ...

, the menu cost is a cost that a

firm A company, abbreviated as co., is a legal entity representing an association of people, whether natural, legal or a mixture of both, with a specific objective. Company members share a common purpose and unite to achieve specific, declared ...

incurs due to changing its prices. It is one

microeconomic Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics fo ...

explanation of the price-stickiness of the

macroeconomy Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, and ...

put by

New Keynesian New Keynesian economics is a school of macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroec ...

economists. The term originated from the cost when

restaurant A restaurant is a business that prepares and serves food and drinks to customers. Meals are generally served and eaten on the premises, but many restaurants also offer take-out and food delivery services. Restaurants vary greatly in appearan ...

s print new menus to change the prices of items. However

economists An economist is a professional and practitioner in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy. Within this field there are ...

have extended its meaning to include the costs of changing

prices A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in t ...

more generally. Menu costs can be broadly classed into costs associated with informing the

consumer A consumer is a person or a group who intends to order, or uses purchased goods, products, or services primarily for personal, social, family, household and similar needs, who is not directly related to entrepreneurial or business activities. ...

, planning for and deciding on a price change and the impact of consumers potential reluctance to buy at the new price. Examples of menu costs include updating

computer systems A computer is a machine that can be programmed to carry out sequences of arithmetic or logical operations (computation) automatically. Modern digital electronic computers can perform generic sets of operations known as programs. These program ...

, re-tagging items, changing signage, printing new menus, mistake costs and hiring consultants to develop new

pricing strategies A business can use a variety of pricing strategies when selling a product or service. To determine the most effective pricing strategy for a company, senior executives need to first identify the company's pricing position, pricing segment, prici ...

. At the same time, companies can reduce menu costs by developing intelligent pricing strategies, thereby reducing the need for changes.

Menu costs and nominal rigidity

Menu costs are the costs incurred by the business when it changes the prices it offers customers. 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. So, menu costs are one factor that can contribute to

nominal rigidity Nominal rigidity, also known as price-stickiness or wage-stickiness, is a situation in which a nominal price is resistant to change. Complete nominal rigidity occurs when a price is fixed in nominal terms for a relevant period of time. For exampl ...

. Firms are faced with the decision to alter prices frequently as a result of changes in the general price level, product costs, market structure, regulation and demand level. Despite frequent market changes, businesses may be hesitant to update prices to reflect these changes due to menu costs. If the menu cost outweighs the expected increase in revenue associated with the price change firms would prefer to exist in disequilibrium and stay at the original price level. When the

nominal price In economics, nominal value is measured in terms of money, whereas real value is measured against goods or services. A real value is one which has been adjusted for inflation, enabling comparison of quantities as if the prices of goods had not c ...

level remains constant despite market change is said that there is

or price stickiness in the market. For example, a restaurant should not change its prices until the price change generates enough additional

revenue In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business. Commercial revenue may also be referred to as sales or as turnover. Some companies receive rev ...

to cover the cost of printing a new menu. Thus, menu costs can create considerable nominal rigidity in other industries or markets, essentially amplifying their impact on the entire industry through a

chain reaction A chain reaction is a sequence of reactions where a reactive product or by-product causes additional reactions to take place. In a chain reaction, positive feedback leads to a self-amplifying chain of events. Chain reactions are one way that sys ...

suppliers In commerce, a supply chain is a network of facilities that procure raw materials, transform them into intermediate goods and then final products to customers through a distribution system. It refers to the network of organizations, people, activ ...

and

distributor A distributor is an enclosed rotating switch used in spark-ignition internal combustion engines that have mechanically timed ignition. The distributor's main function is to route high voltage current from the ignition coil to the spark plug ...

History

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 In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...

on the frequency of price changes. Sheshink and Weiss concluded that even fully anticipated

results in an actual menu cost for the business. They suggested that

business Business is the practice of making one's living or making money by producing or buying and selling products (such as goods and services). It is also "any activity or enterprise entered into for profit." Having a business name does not separ ...

es will change prices in discrete jumps rather than continual changes when in an

ary environment. This justifies the fixed costs of changing prices when revenues are expected to increase. The idea of applying menu costs as an aspect of Nominal Price Rigidity was simultaneously put forward by several New Keynesian economists in 1985–6.In 1985,

Gregory Mankiw Nicholas Gregory Mankiw (; born February 3, 1958) is an American macroeconomist who is currently the Robert M. Beren Professor of Economics at Harvard University. Mankiw is best known in academia for his work on New Keynesian economics. Mankiw ...

concluded that even small menu costs create inefficient price adjustment and push equilibrium below the point which is socially optimal. He further suggested that the subsequent loss of welfare far exceeds the menu cost that causes it. Michael Parkin also put forward the idea.

George Akerlof George Arthur Akerlof (born June 17, 1940) is an American economist and a university professor at the McCourt School of Public Policy at Georgetown University and Koshland Professor of Economics Emeritus at the University of California, Berkeley ...

and

Janet Yellen Janet Louise Yellen (born August 13, 1946) is an American economist serving as the 78th United States secretary of the treasury since January 26, 2021. She previously served as the 15th chair of the Federal Reserve from 2014 to 2018. Yellen is ...

put forward the idea that due to

bounded rationality Bounded rationality is the idea that rationality is limited when individuals make decisions, and under these limitations, rational individuals will select a decision that is satisfactory rather than optimal. Limitations include the difficulty o ...

firms will not want to change their price unless the benefit is more than a small amount. This

leads to inertia in nominal prices and wages which can lead to output fluctuating at constant nominal prices and wages. The menu cost idea was also extended to wages as well as prices by

Olivier Blanchard Olivier Jean Blanchard (; born December 27, 1948) is a French economist and professor who is a senior fellow at the Peterson Institute for International Economics. He was the chief economist at the International Monetary Fund from September 1, 2 ...

and Nobuhiro Kiyotaki. The

new Keynesian New Keynesian economics is a school of macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroec ...

explanation of price stickiness relied on introducing

imperfect competition In economics, imperfect competition refers to a situation where the characteristics of an economic market do not fulfil all the necessary conditions of a perfectly competitive market. Imperfect competition will cause market inefficiency when it hap ...

with price (and wage) setting agents. This started a shift in

macroeconomics Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, and ...

away from using the model of

perfect competition In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In theoretical models whe ...

with price taking agents to use imperfectly competitive equilibria with price and wage setting agents (mostly adopting

monopolistic competition Monopolistic competition is a type of imperfect competition such that there are many producers competing against each other, but selling products that are differentiated from one another (e.g. by branding or quality) and hence are not perfec ...

Huw Dixon Huw David Dixon (/hju: devəd dɪksən/), born 1958, is a British economist. He has been a professor at Cardiff Business School since 2006, having previously been Head of Economics at the University of York (2003–2006) after being a professor ...

and Claus Hansen showed that even if menu costs were applied to a small sector of the economy, this would influence the rest of the economy and lead to prices in the rest of the economy becoming less responsive to changes in demand. 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. The reason is that such models lack "real rigidity". 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. Modern New Keynesian models address this issue by assuming that the labor market is segmented, so that the expansion in employment by a given firm does not lead to lower profits for the other firms.

Magnitude of menu costs

When a company's menu costs a lot in

economic market In economics, a market is a composition of systems, institutions, procedures, social relations or infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering ...

s, the price adjustment is usually major. The company would not engage in price adjustment if

profit margin Profit margin is a measure of profitability. It is calculated by finding the profit as a percentage of the revenue. \text = = There are 3 types of profit margins: gross profit margin, operating profit margin and net profit margin. * Gross Pro ...

s start to fall to the point where menu costs lead to more revenue losses. The type of company and the

technology Technology is the application of knowledge to reach practical goals in a specifiable and reproducible way. The word ''technology'' may also mean the product of such an endeavor. The use of technology is widely prevalent in medicine, scien ...

used determine factors that change prices and costs. For example, it may be necessary to reprint the latest menu, contact the distributor, to change the price list and the prices of items on the shelf. Menu costs in some industries may be small, but the scale may influence business decisions about whether to reprice. A 1997 study published by

Harvard College Harvard College is the undergraduate college of Harvard University, an Ivy League research university in Cambridge, Massachusetts. Founded in 1636, Harvard College is the original school of Harvard University, the oldest institution of higher ...

and

MIT The Massachusetts Institute of Technology (MIT) is a private land-grant research university in Cambridge, Massachusetts. Established in 1861, MIT has played a key role in the development of modern technology and science, and is one of the m ...

used data from 5 multistore supermarket chains to investigate the magnitude of menu costs. They considered the cost of: # Labour to change shelf prices # Printing and delivering new labels # Mistakes during the changeover process # Supervision during the changeover process Results of the study showed that the menu cost was on average $105,887 per year, per store. This figure comprised 0.7% of revenue, 32.5% of net margins and $0.52/price change. Subsequently in order for updating prices to be beneficial the

profitability In economics, profit is the difference between the revenue that an economic entity has received from its outputs and the total cost of its inputs. It is equal to total revenue minus total cost, including both explicit and implicit costs. It i ...

of an item needed to decrease by more than 32.5%. The study concluded that menu costs have a magnitude large enough to be of

macroeconomic Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, an ...

significance.

Factors influencing menu costs

Pricing regulation Pricing and

regulatory Regulation is the management of complex systems according to a set of rules and trends. In systems theory, these types of rules exist in various fields of biology and society, but the term has slightly different meanings according to context. ...

requirements such as requiring individual price stickers on each item can increase menu costs by increasing the time needed to update prices in stores physically. The study summarised above, which detailed the magnitude of menu costs in multistore supermarkets, also investigated the impact of pricing

laws Law is a set of rules that are created and are enforceable by social or governmental institutions to regulate behavior,Robertson, ''Crimes against humanity'', 90. with its precise definition a matter of longstanding debate. It has been vari ...

that required individual price tags to be placed on items. The study found that menu costs were 2.5 times higher for the store impacted by the local pricing requirements. Further, firms not subject to the requirements were found to change the prices of 15.6% of products every week compared to 6.3% of products in the chain subject to the laws. Number of product variants A 2015 study published by the MIT Press, used data from a national retailer operating a large number of stores selling groceries, health and beauty products to investigate the impact of that the number of

product Product may refer to: Business * Product (business), an item that serves as a solution to a specific consumer problem. * Product (project management), a deliverable or set of deliverables that contribute to a business solution Mathematics * Produ ...

variants has on the frequency of price change. The study concluded that

cost In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something or deliver a service, and hence is not available for use anymore. In business, the cost may be one of acquisition, in whic ...

increases led to price increases on 71.2% of occasions for products with a single variant compared to 59.8% of the time where there were seven or more variants. This result was linked with the increased price stickiness associated with the additional cost of labour required to change the price of multiple items. Industry/market A shift to

e-commerce E-commerce (electronic commerce) is the activity of electronically buying or selling of products on online services or over the Internet. E-commerce draws on technologies such as mobile commerce, electronic funds transfer, supply chain manag ...

has seen a decrease in menu costs. A study on the price setting of

Amazon Fresh Amazon Fresh is a subsidiary of the American e-commerce company Amazon in Seattle, Washington. It is a grocery retailer with physical stores and delivery services in most major U.S. cities, as well as some international cities, such as Berlin, H ...

(an online grocery store) found that product prices of the online retailer are less rigid than the prices of traditional

brick and mortar Brick and mortar (also bricks and mortar or B&M) refers to a physical presence of an organization or business in a building or other structure. The term ''brick-and-mortar business'' is often used to refer to a company that possesses or leases r ...

grocery stores. The study found that on average a product listed on Amazon Fresh had 20.4 price changes in a year and the

median In statistics and probability theory, the median is the value separating the higher half from the lower half of a data sample, a population, or a probability distribution. For a data set, it may be thought of as "the middle" value. The basic f ...

magnitude of these changes was 10%. The study suggests that decreased pricing rigidity could be attributable to automated pricing algorithms allowing businesses to respond in real time to market shocks.

Analysing menu cost

When to use menu cost Consider a firm in a hypothetical economy, with a normally distributed graph describing the relationship between the

price A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the ...

of its goods and the firm's corresponding

profit Profit may refer to: Business and law * Profit (accounting), the difference between the purchase price and the costs of bringing to market * Profit (economics), normal profit and economic profit * Profit (real property), a nonpossessory inter ...

. The firm seeks to maximise profit at the corresponding price value M. Now suppose a shock to the market shifts the profit curve to a new theoretical model. The firm must decide whether to maintain price M with a suboptimal profit level, A, or adjust the price to N, which corresponds to the new maximised profit level, B. Let menu cost (the cost of adjusting prices) equal Z. If Z < B - A, then the menu cost is less than the theoretical increase in profits and adjusting prices to N is economically profitable. Daily fluctuations in the

economy An economy is an area of the production, distribution and trade, as well as consumption of goods and services. In general, it is defined as a social domain that emphasize the practices, discourses, and material expressions associated with th ...

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. 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. Finding menu cost Menu cost encompasses the cost of informing consumers in the form of advertising and labour involved in repricing/ repackaging, as well as information cost for accurate profit curves and quantity demanded. Z(q_i,r_j,s_k) = A(q_1,...,q_i) + L(r_1,...,r_j) + N(s_1,...,s_k) Where A, L, and N are advertising, labour and information respectively and i, j, k are integers equal to the number of variables required for each function (e.g. L(r_1,r₂) is the

production function In economics, a production function gives the technological relation between quantities of physical inputs and quantities of output of goods. The production function is one of the key concepts of mainstream neoclassical theories, used to define ...

Labour cost of repackaging using wage per hour and quantity of boxes as two variables, therefore, j = 2). Each firm will have a different set of A, L and N functions depending on their market and firm structure. It can be reported by examining th
menu prices of the restaurants
in detail.

References