... Keynesian models is that of imperfect competition. All the major innovations of the New Keynesian school are made possible or worthwhile only because of imperfect competition. By this I mean that all the firms set their own profit-maximizing prices rather than take from the market. So what are exactly menu costs? Menu costs are costs of changing nominal price. The classic example of menu costs is the costs that a restaurant faces when it has to reprint its menu to show changes in the prices of its offerings. More general examples of menu costs include costs of remarking merchandise, reprinting price lists and catalogues, and informing potential customers. The New Keynesian approach assumes that small menu costs will deter imperfectly competitive firms from constantly changing their prices. After the definition let us turn to find out the role of menu costs. Suppose there is an increase in aggregate demand ...

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