Sticky-Price Model

Sticky-price models explain why nominal shocks can move real output in the short run. If some firms cannot reset prices, aggregate demand changes translate partly into quantities instead of only prices.

Taylor contracts and Calvo pricing are two canonical ways to formalize sluggish price adjustment. The route uses a simplified aggregate version to show the real effect of nominal rigidity.

The model is a foundation for New Keynesian monetary policy. It gives the central bank a short-run output-inflation tradeoff while preserving long-run monetary neutrality.

A fraction of firms keep old prices while flexible firms reset toward desired prices. The aggregate price level is a weighted average of sticky and flexible prices.

When money or nominal spending rises unexpectedly, sticky-price firms cannot raise prices immediately. Their relative prices fall, demand for their goods rises, and output expands.

As more prices adjust, the real effect fades. The long-run impact of a nominal shock is on the price level, not real output.

Monetary-policy transmission depends on price rigidity. Greater stickiness makes real output more responsive to nominal-rate or money shocks.

Inflation persistence can reflect staggered contracts, menu costs, indexation, or information frictions. The route focuses on price rigidity, not every source of persistence.

Policy analysis should not assume all sectors are equally sticky. Services, rents, and administered prices adjust differently from commodities and traded goods.