Final answer:
Firms' ability to pass on higher input costs to consumers or keep savings from lower production costs depends on the price elasticity of demand, which dictates the market's responsiveness to price changes.
Step-by-step explanation:
Businesses often strive to produce at a lower cost to achieve higher profits, but they sometimes encounter rising prices of key inputs, over which they have no control. The ability of a firm to pass on higher costs to consumers through increased prices or keep the benefits of reduced production costs as higher profits is largely influenced by the price elasticity of demand. When key input costs rise, companies in markets with inelastic demand may be able to increase prices without losing much sales volume, while firms in markets with elastic demand might not be able to do so without significantly decreasing their sales volume. Similarly, if production costs decrease, whether firms can retain those savings as profits or must pass them on to consumers in the form of lower prices also depends on the price elasticity of demand.