Demand and supply: the relationship between price elasticities and profitability in the UK

This paper investigates the relationship between consumer demand and firms'' mark-up for several products in the UK, using two independent datasets. It uses data on consumer expenditures and the retail price index to estimate Almost Ideal Demand Systems on micro-data and compute time-varying price elasticities of demand for disaggregated commodity groups. Then, it matches the product definitions to the Standard Industry Classification and uses the estimated elasticities to investigate the impact of consumer behaviour on firm-level profitability equations. The time-varying household characteristics are ideal instruments for the demand effects in the firms'' supply equation. The paper concludes that demand elasticities have a significant and tangible impact on the profitability if UK firms and that this impact can shed some light on the relationship between market structure and economic performance.