How Large are Non-Budget-Constraint Effects of Prices on Demand?
American Economic Journal: Applied Economics, Vol. 1, No. 4, pp. 170–199
53 Pages Posted: 16 May 2008 Last revised: 28 Apr 2010
Date Written: March 19, 2009
Elementary consumer theory assumes that prices affect demand only because they affect the budget constraint (BC). By contrast, several models suggest that prices can affect demand through other channels (e.g. because they signal quality). This alternative conjecture is consistent with evidence from marketing studies. However, neither theory nor evidence is informative regarding the magnitude of non-BC effects. The key econometric challenge arises from the fact that a change in prices typically also changes the BC. This paper uses a lab and a field experiment to disentangle BC from non-BC effects of prices on demand. In our lab experiment we find that, consistent with marketing evidence, prices positively affect stated willingness to pay. However, when examining actual demand, non-BC price elasticities are considerably smaller than BC price elasticities and are often statistically insignificant. Further, these non-BC elasticities do not increase with product uncertainty. Finally, we do not detect any non-BC effects in our field experiment.
Keywords: consumer behavior, demand, price, quality signals, experiments
JEL Classification: D01, D12, D8, M31
Suggested Citation: Suggested Citation