Business Profit and Consumer Price Sensitivity

Abstract

In this paper, we investigate the relation between business profit and the demand price-elasticity of consumers. Business profit increases with a decrease in customer price-sensitivity only when the relation between a firm’s net operating margin (after fixed-costs) and its price-cost margin (before fixed-costs) exceeds unity. We find this result empirically for firms in five industries that we investigate. However, we also find that advertising increases customer price-sensitivity. Nonetheless, businesses advertise because the positive profit impact of higher unit sales offsets the negative profit impact of greater customer price-sensitivity to increase profit on net. We conclude that the increase in customer price-sensitivity from advertising is not purposeful and that businesses cannot manipulate consumer tastes for higher profit.

Keywords: Business profit, estimating customer price-sensitivity, advertising

JEL Classification: D11, D12, D21, D22