Why do firms not change their prices very frequently? Obviously, the costs of changing prices at frequent intervals and in small amounts must be more than the benefits obtained from such a change. Firms prefer to wait before they make price changes in relatively large amounts and in the mean time absorb the losses that they would suffer by not changing prices. This of course presumes that the firms have some monopolistic price setting power and the losses referred to above include lower profits than would have been possible if prices had been raised, and not necessarily actual out-of-pocket losses.
It is easy to understand this behaviour of monopolistically competitive firms through the example of restaurants competing with each other. The term 'menu costs' immediately becomes meaningful as the costs that would be incurred in changing the menu cards every time there is a change in the prices of items on the menu. These printing costs are surely negligible, but the more important costs are in terms of the loss of customers that a firm would face if it subjects its clientele to the 'irritability' of continuous, small changes in prices. The concept of menu costs in a modem economy is indeed broad. It is also widely applicable, given the proliferation of automatic dispensers (e.g., coffee machines) and pay telephones that operate on coins.
It is easy to imagine the cost that would be incurred by the suppliers if these ubiquitous machines were to be adjusted every time a price change is effected. The firms would rather not change their prices. It is this idea of weighing the costs of changing prices against the benefits obtained from changing prices that is formalised in the Mankiw model that we consider below.