Menu Costs

Menu Costs

Menu costs are the costs firms incur when they change prices. These can be literal (reprinting menus or price tags) or indirect (updating systems, contacting distributors, or losing sales while customers adjust). Menu costs help explain why many prices are “sticky”—slow to respond to changes in costs or demand—and are a central idea in New Keynesian explanations of nominal price rigidity.

Key takeaways

• Menu costs are the expenses associated with changing prices.
• They create price-stickiness: firms delay adjustments until the expected benefit exceeds the cost of changing prices.
• Even small menu costs can have large macroeconomic effects by preventing prices and wages from adjusting smoothly.
• Businesses can reduce menu costs through pricing strategy, technology, and operational changes.

How menu costs work

Firms compare the expected gain from a price change to the cost of implementing it. If the gain is smaller than the menu cost, the firm leaves prices unchanged. This decision produces discrete, infrequent price adjustments rather than continuous updating, which can magnify economic shocks and delay market clearing.

Examples of menu cost components:
* Physical printing or re-tagging (menus, labels, price stickers).
IT and systems updates (point-of-sale, e-commerce listings).
Administrative actions (revising contracts, informing suppliers and distributors).
Marketing and customer-relations costs (explaining price changes, temporary promotional strategies).
Behavioral costs (customers’ hesitation to buy at a new price, lost goodwill).

Brief history and theory

• 1977: Sheshinski and Weiss introduced the idea that firms face fixed costs when adjusting prices, causing prices to change in discrete jumps during inflationary periods.
• 1980s: New Keynesian economists (notably Mankiw) argued that even small menu costs can generate significant nominal rigidity and macroeconomic consequences.
• Akerlof and Yellen highlighted behavioral limits (bounded rationality) that add inertia to price and wage changes.
• Empirical work (e.g., supermarket chain studies) has shown that menu costs can be substantial relative to profit margins, making repricing costly for retailers.

Industry effects and variation

Menu costs differ by industry and technology:
* High menu costs: industries requiring physical re-tagging, extensive distribution updates, or regulated price labeling tend to change prices infrequently.
Low menu costs: digitally managed inventories and dynamic pricing platforms allow rapid, low-cost updates.
When input costs fall, firms often keep prices unchanged and capture higher margins until competition forces price cuts—adjustments downward frequently occur via promotions rather than permanent price reductions.

Common examples

• Restaurants printing new menus after ingredient or wage cost changes.
• Supermarkets re-tagging shelf prices or updating barcode databases.
• Service providers (salons, health care clinics) keeping posted prices stable despite underlying cost changes.
• Entertainment and media (movie tickets, books) where prices change only occasionally.

Why menu costs matter

Because prices and wages adjust in steps rather than continuously, menu costs can:
* Prolong mismatches between supply and demand.
Amplify business cycles by preventing quick price responses to shocks.
Force firms to choose between absorbing margin losses or incurring costly repricing.

How businesses can reduce menu costs

• Adopt digital pricing systems and centralized price management to minimize manual updates.
• Use clear pricing tiers or bundled offers to reduce the need for frequent micro-adjustments.
• Implement data-driven pricing strategies that anticipate necessary changes and group updates.
• Use promotions and temporary discounts to respond to cost changes without permanent relabeling.
• Negotiate flexible supplier contracts to smooth input-cost volatility.

Conclusion

Menu costs are a practical and theoretical explanation for why many prices are sticky. They combine direct implementation expenses with behavioral and organizational frictions. Reducing menu costs—through technology, smarter pricing design, and operational efficiency—helps firms respond more quickly to market changes and can mitigate some macroeconomic rigidity.

Selected references

• Sheshinski, E., & Weiss, Y. (1977). Inflation and Costs of Price Adjustment. Review of Economic Studies.
• Mankiw, N. G. (1985). Small Menu Costs and Large Business Cycles. Quarterly Journal of Economics.
• Akerlof, G. A., & Yellen, J. L. (1985). Can Small Deviations from Rationality Make Significant Differences to Economic Equilibria? American Economic Review.
• Levy, D., et al. (1997). Magnitude of Menu Costs: Direct Evidence From Large Supermarket Chains. Quarterly Journal of Economics.