Illustration of How Lag Effect Dampens and Slows Retail Price Changes from Wholesale

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• This example illustrates in a simple way how the lag effect keeps retail prices from dropping as fast as they rise.

• Before the retail price has reflected all of a wholesale price increase (10 cents), the wholesale price usually begins to fall. The decrease in the wholesale price begins to be passed on to the consumer on top of the remaining wholesale price increases, which slows the retail price increase. The net result is to dampen the rise and fall of retail prices relative to wholesale prices, to cause retail prices to peak later than wholesale prices, and to cause retail prices to fall at a slower rate than they rise. The retail market simply reflects the wholesale price changes spread out over a longer time.