Recent Developments in Empirical IO: Dynamic Demand and Dynamic Games

Empirically studying dynamic competition in oligopoly markets requires dealing with large states spaces and tackling difficult computational problems, while handling heterogeneity and multiple equilibria. In this paper, we discuss some of the ways recent work in Industrial Organization has dealt with these challenges. We illustrate problems and proposed solutions using as examples recent work on dynamic demand for differentiated products and on dynamic games of oligopoly competition. Our discussion of dynamic demand focuses on models for storable and durable goods and surveys how researchers have used the \Industrial Organization; Oligopoly competition; Dynamic demand; Dynamic games; Estimation; Counterfactual experiments; Multiple equilibria; Inclusive values; Unobserved heterogeneity.

MEASURING MARKET POWER USING DISCRETE CHOICE MODELS OF DEMAND: AN APPLICATION TO THE READY-TO-EAT CEREAL INDUSTRY

Market power, consumer demand, cereal industry, Demand and Price Analysis,

Using Weights to Adjust for Sample Selection When Auxiliary Information is Available

In this paper I analyze GMM estimation when the sample is not a random draw from the population of interest. I exploit auxiliary information, in the form of moments from the population of interest, in order to compute weights that are proportional to the inverse probability of selection. The essential idea is to construct weights, for each observation in the primary data, such that the moments of the weighted data are set equal to the additional moments. The estimator is applied to the Dutch Transportation Panel, in which refreshment draws were taken from the population of interest in order to deal with heavy attrition of the original panel. I show how these additional samples can be used to adjust for sample selection.

New Products, Quality Changes and Welfare Measures Computed From Estimated Demand Systems

This paper examines the construction of a price index based on an estimated demand system. In principle the method examined can produce a price index that accounts for introduction of new products and quality changes in existing products. However, I isolate two key assumptions that have to be made in order to interpret the demand estimates into welfare measures. Using estimates of a brand-level demand system for ready-to-eat cereal I demonstrate the empirical importance of the assumptions. For the data I use, depending on the interpretation of the demand estimates, a price index can range between a 35% percent increase over the five years examined to a 2.4% decrease.

Sales and Consumer Inventory

Temporary price reductions (sales) are common for many goods and naturally result in large increase in the quantity sold. We explore whether the data support the hypothesis that these increases are, at least partly, due to dynamic consumer behavior: at low prices consumers stockpile for future consumption. This effect, if present, renders standard static demand estimates misleading, which has broad economic implications. We construct a dynamic model of consumer choice, use it to derive testable predictions and test these predictions using two years of scanner data on the purchasing behavior of a panel of households. The results support the existence of household stockpiling behavior and suggest that static demand estimates, which neglect dynamics, may overestimate price sensitiveness by up to a factor of 2 to 6.

Why Does the Average Price of Tuna Fall During Lent?

For many products the average price paid by consumers falls during periods of high demand. We use information from a large supermarket chain to decompose the decrease in the average price into a substitution effect, due to an increase in the share of cheaper products, and a price reduction effect. We find that for almost all the products we study the substitution effect explains a large part of the decrease. We estimate demand for these products and show the price declines are consistent with a change in demand elasticity and the relative demand for different brands. Our findings are less consistent with "loss-leader" models of retail competition.

Identification with imperfect instruments

Dealing with endogenous regressors is a central challenge of applied research. The standard solution is to use instrumental variables that are assumed to be uncorrelated with unobservables. We instead assume (i) the correlation between the instrument and the error term has the same sign as the correlation between the endogenous regressor and the error term, and (ii) that the instrument is less correlated with the error term than is the endogenous regressor. Using these assumptions, we derive analytic bounds for the parameters. We demonstrate the method in two applications.

Prices and Coupons for Breakfast Cereals

This paper explores the relationship between shelf prices and manufacturers' coupons for 25 ready-to-eat breakfast cereals. Contrary to the predictions of static monopoly price discrimination, we find the shelf prices for a particular brand in a particular city are generally lower during periods when coupons are available. We find evidence that is also inconsistent with dynamic theories of pricing that predict lower prices and coupons after periods of low demand, and find little support for explanations of couponing based on the vertical relationship between manufacturers and retailers. We find some support for models of price discrimination in oligopoly settings that suggest inter-brand competition can cause all prices to be lower than the uniform (non-discriminatory) price. We also find some evidence suggesting that firm-wide incentives may induce managers to use coupons and price cuts simultaneously in order, for example, to meet market share targets.

Recent developments in empirical IO: dynamic demand and dynamic games

Empirically studying dynamic competition in oligopoly markets requires dealing with large states spaces and tackling difficult computational problems, while handling heterogeneity and multiple equilibria. In this paper, we discuss some of the ways recent work in Industrial Organization has dealt with these challenges. We illustrate problems and proposed solutions using as examples recent work on dynamic demand for differentiated products and on dynamic games of oligopoly competition. Our discussion of dynamic demand focuses on models for storable and durable goods and surveys how researchers have used the "inclusive value" to deal with dimensionality problems and reduce the computational burden. We clarify the assumptions needed for this approach to work, the implications for the treatment of heterogeneity and the different ways it has been used. In our discussion of the econometrics of dynamics games of oligopoly competition, we deal with challenges related to estimation and counterfactual experiments in models with multiple equilibria. We also examine methods for the estimation of models with persistent unobserved heterogeneity in product characteristics, firms’ costs, or local market profitability. Finally, we discuss different approaches to deal with large state spaces in dynamic games.Industrial Organization; Oligopoly competition; Dynamic demand; Dynamic games; Estimation; Counterfactual experiments; Multiple equilibria; Inclusive values; Unobserved heterogeneity.

Sales and Consumer Inventory

Temporary price reductions (sales) are quite common for many goods and usually result in an increase in the quantity sold. We explore whether the data support the hypothesis that these increases are, at least partly, due to dynamic consumer behavior: at low prices consumers stockpile for future consumption. This effect, if present, has broad implications for interpretation of demand estimates. We construct a dynamic model of consumer choice and use it to derive testable predictions. We test the implications of the model using two years of store-level scanner data and data on the purchases of a panel of households over the same time. The results support the existence of household stockpiling behavior.