How Large are Non-Budget-Constraint Effects of Prices on Demand?
Cornell University - S.C. Johnson Graduate School of Management; Hebrew University of Jerusalem; National Bureau of Economic Research (NBER)
The Hebrew University of Jerusalem - Department of Economics
March 19, 2009
American Economic Journal: Applied Economics, Vol. 1, No. 4, pp. 170–199
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.
Number of Pages in PDF File: 53
Keywords: consumer behavior, demand, price, quality signals, experiments
JEL Classification: D01, D12, D8, M31
Date posted: May 16, 2008 ; Last revised: April 28, 2010