Working Paper: NBER ID: w12152
Authors: Steven D. Levitt
Abstract: Profit maximizing behavior on the part of firms is a fundamental, but rarely tested, assumption of economics. In this paper, I analyze the decisions made by an MIT trained economist running a company that delivers bagels and donuts. The simplicity and transparency of the business (e.g. marginal cost is easily observed) allow for direct tests of profit maximization in the quantities delivered each day and the prices that are charged. Using thirteen years of data representing more than 80,000 deliveries, I find that the company is extremely adept at determining how many bagels and donuts to deliver to a particular customer on a given day. In stark contrast, the company appears to price on the inelastic portion of the demand curve for the entire period, thereby foregoing a substantial share of available profits. I argue that these results generalize well beyond this particular case study: firms are likely to be close to the efficient frontier on dimensions for which there is frequent and informative feedback regarding profits, but absent that feedback, systematic deviations from profit maximization are more likely.
Keywords: No keywords provided
JEL Codes: L2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| observed demand signals (R22) | quantity delivered (L87) |
| quantity delivered (L87) | profit maximization (L21) |
| pricing decisions (L11) | overall firm profitability (L21) |
| price increases (E30) | revenues and profits (H27) |