The Keynesian model is built on a key assumption. It assumes that firms do not respond to every change in demand for their products by changing their prices. They typically set a price for some period, and then meet the demand at that price.
The main argument for why the firms might fix prices in the short run is that changing price involves menu cost. Menu cost may include the cost of printing a new menu, the cost of doing a market research to determine the new price and the cost of informing the customers about the price changes. The decision of changing price is based on the cost-benefit analysis. That means prices should be changed if the benefit of changing it, such as the increase in revenue after price adjustment, outweighs the menu costs associated with making the change.
Moreover, another argument is the firms have the fear of losing market share after a price adjustment. Assuming the products are identical, when a firm reduces its product price and other competitive firms keep the price unchanged, the market share of that firm will be lost.
Costs, demand, competitor movements, exchange rate movement are considered to be the main factors in driving price adjustment. The pricing strategies differed significantly across industries. For example, some will apply cost-focused strategy such as cost-plus mark-up percentage; others apply demand-focused strategies for their price setting. Among them, it is said that firms using a simple cost-based approach such as may
