>Assume a company has gross margins of 100%,
First, gross margin is not net profit, which more accurately represents what a company could possibly absorb. Second, no industry has even gross margins near 100%; more accurate is around ~35% [1] .
Assume a company has actual net profits of 5% (more in line with actual net profits), and cost of goods (or labor) goes up 10-20% (and same for all their competitors, since all are sourcing goods in the same markets).
Then they pass cost on to consumers or go out of business.
This is a more accurate model using real world numbers from the current economy.