What Are the Menu Costs?

When businesses change their pricing, they incur some transaction costs. Menu costs are one microeconomic explanation proposed by New Keynesian economists for macroeconomic pricing stickiness, which can lead to an economy failing to react to changing macroeconomic conditions.

Understanding Menu Pricing

Menu costs are the expenses experienced by a firm when the pricing it offers to its customers varies. A typical example is a restaurant that must physically print fresh menus when its dish prices change.

The key conclusion from menu prices is that some prices are unaffordable. That is, firms are unwilling to modify their pricing until there is a significant enough difference between their current price and the equilibrium market price to justify incurring the menu cost.

For example, a restaurant should not modify its prices until the additional money generated is sufficient to pay for printing new menus. In practice, however, determining the equilibrium market pricing or accounting for all menu expenses may be challenging, making it impossible for enterprises and consumers to behave precisely in this manner.

The Origins of the Menu Costs Concept

Menu costs were first proposed by economists Eytan Sheshinski and Yoram Weiss in 1977.

Sheshinski and Yoram suggested that in an inflationary environment, firms’ prices will rise in repeated, discrete leaps when the predicted gain in revenue justifies incurring the fixed cost of changing the price.

Later, New Keynesian economists used the argument to develop a general theory of nominal price rigidity. Economists used it to explain price stickiness and its function in propagating macroeconomic swings. Gregory Mankiw’s 1985 article stated that even tiny menu expenses could induce enough pricing rigidity to have a significant macroeconomic impact.

According to George Akerlof and Janet Yellen, firms will not modify their prices due to bounded rationality unless the benefit is more than a small amount. Because of this constrained rationality, nominal prices and wages have inertia, causing output to fluctuate at constant nominal prices and earnings.

The Impact of Menu Prices on the Industry

Price adjustments are frequently infrequent when menu costs are high in a sector. They often occur only when the profit margin begins to shrink to the extent that eliminating menu costs leads to more revenue loss.

The cost of changing prices is determined by the type of company and the technology used. For example, reprinting menus, updating price lists, contacting a distribution and sales network, or manually re-tagging products on the shelf may be required. Even if there are few obvious menu costs, increasing pricing may make customers hesitant to purchase at the new price. This purchase hesitation might have a subtle menu cost in the form of wasted potential sales.

Menu costs may be low in some industries, but there is generally enough friction and cost at scale to affect the business choice to reprice or not. A 1997 study investigated store-level data from five multi-store supermarket chains to measure menu expenses directly.

According to the survey, menu costs per shop averaged more than 35% of net profit margins. This means that item profitability had to fall by more than 35% to justify revising the ultimate price of the products.

The authors contended that menu costs could induce significant nominal rigidity in other industries or markets—a ripple effect across suppliers and distributors—thus compounding their effects on the industry.

Factors Influencing Industry Pricing

Menu prices vary greatly depending on geography and industry. This could be owing to municipal restrictions requiring a distinct price tag on each item, raising menu prices. Alternatively, because there are fewer fixed contract suppliers, there may be fewer restrictions on price modification.

There are also differences in the rate of price constraints. For example, digitally controlled and sold inventory has negligible menu costs, and pricing changes may be made globally with a few clicks. Prices are often not updated unless they must be due to high menu costs. The adjustment is frequently upward for many commodities. Product marketers tend to keep the extra margin when input costs fall until competition drives them to reprice. Rather than a legitimate price adjustment, this is frequently accomplished through promotional pricing.

FAQs about Menu Prices

In Economics, What Is Menu Cost Theory?

The effect of a pricing change on a commercial organization is reflected in menu cost theory. Therefore, a restaurant that alters its prices must incur the cost of printing new menus, which is the traditional example used to explain the notion.

Generally, the costs to a firm of adjusting nominal pricing are referred to as menu costs. Every time a company raises or lowers its prices, it incurs significant financial costs. Another consideration for menu prices is that they must rise with inflation. Menu expenditures are thus unavoidable to some extent.

Which Costs Can Be Included in Menu Prices?

Menu costs might comprise any costs incurred due to a company adjusting its prices. Examples of these costs are printing menus, updating computer systems, re-tagging things, or paying experts to assist with pricing strategy. Menu expenses can also include customer reluctance to buy at the new price.

Are Menu Costs the Costs of Price Changes?

Yes. The expense of adjusting pricing results in menu costs. Typically, purveyors must modify their prices to keep up with inflation or lower their prices to be more competitive in the market. In any case, there will be associated costs.

Why Do Menu Prices Increase?

Menu expenses usually are the result of inflation. For example, if the cost of food, rent, or wages increases, a restaurant will have to raise its rates to pay for the extra cost and make the same profit. There are additional expenditures when raising pricing, such as printing new menus, updating the website, etc. This means the restaurant will suffer extra costs merely because of inflation.

How Can I Cut Menu Costs?

A good pricing strategy is essential for lowering menu costs. Businesses should conduct a market analysis to identify how they vary from their local competition. This will demonstrate where their value lies in customers’ eyes and can assist them in pricing their items efficiently while considering the products and prices of their competitors. These methods should keep a company from modifying its prices too frequently or, worse, from having to lower them.

What is an example of infrequently changing pricing?

Sticky prices occur when prices do not react or react slowly to changes in demand, production costs, etc. Food in supermarkets is notoriously sticky, at least for a short period. For example, if the price of tomatoes falls, Chef Boyardee is unlikely to drop its prices, even if input costs fall. Instead, the food manufacturer would take the higher profit margin. In this case, consumers see no difference in price even though it should have been reduced according to traditional supply and demand equations.

This also works the other way around. Olive Garden is unlikely to raise its pasta prices simply because the cost of one component rises. Hair cuts, health care, and entertainment items like books and movie tickets are other examples of sticky prices.

Conclusion

• Menu costs are the costs a company has to pay when it changes its prices.
• One reason for price-stickiness is menu costs, a central idea in New Keynesian economics.
• Price-stickiness means that prices don’t change when the economy as a whole does.
• When prices don’t change with inflation, it can worsen the economy.
• Companies can lower menu costs by developing an intelligent price strategy so that fewer changes are necessary.