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Logit Demand Estimation Under Competitive Pricing Behavior: An Equilibrium Framework

  • David Besanko

    (Kellogg Graduate School of Management, Northwestern University, Evanston, Illinois 60208)

  • Sachin Gupta

    (Kellogg Graduate School of Management, Northwestern University, Evanston, Illinois 60208)

  • Dipak Jain

    (Kellogg Graduate School of Management, Northwestern University, Evanston, Illinois 60208)

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    Discrete choice models of demand have typically been estimated assuming that prices are exogenous. Since unobservable (to the researcher) product attributes, such as coupon availability, may impact consumer utility as well as price setting by firms, we treat prices as endogenous. Specifically, prices are assumed to be the equilibrium outcomes of Nash competition among manufacturers and retailers. To empirically validate the assumptions, we estimate logit demand systems jointly with equilibrium pricing equations for two product categories using retail scanner data and cost data on factor prices. In each category, we find statistical evidence of price endogeneity. We also find that the estimates of the price response parameter and the brand-specific constants are generally biased downward when the endogeneity of prices is ignored. Our framework provides explicit estimates of the value created by a brand, i.e., the difference between consumers' willingness to pay for a brand and its cost of production. We develop theoretical propositions about the relationship between value creation and competitive advantage for logit demand systems and use our empirical results to illustrate how firms use alternative value creation strategies to accomplish competitive advantage.

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    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 44 (1998)
    Issue (Month): 11-Part-1 (November)
    Pages: 1533-1547

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    Handle: RePEc:inm:ormnsc:v:44:y:1998:i:11-part-1:p:1533-1547
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    1. Pradeep K. Chintagunta & Vithala R. Rao, 1996. "Pricing Strategies in a Dynamic Duopoly: A Differential Game Model," Management Science, INFORMS, vol. 42(11), pages 1501-1514, November.
    2. Peter M. Guadagni & John D. C. Little, 1983. "A Logit Model of Brand Choice Calibrated on Scanner Data," Marketing Science, INFORMS, vol. 2(3), pages 203-238.
    3. Berry, Steven & Levinsohn, James & Pakes, Ariel, 1995. "Automobile Prices in Market Equilibrium," Econometrica, Econometric Society, vol. 63(4), pages 841-90, July.
    4. Adam M. Brandenburger & Harborne W. Stuart, 1996. "Value-based Business Strategy," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 5(1), pages 5-24, 03.
    5. Allenby, Greg M & Rossi, Peter E, 1991. "There Is No Aggregate Bias: Why Macro Logit Models Work," Journal of Business & Economic Statistics, American Statistical Association, vol. 9(1), pages 1-14, January.
    6. Gallant, A. Ronald, 1975. "Seemingly unrelated nonlinear regressions," Journal of Econometrics, Elsevier, vol. 3(1), pages 35-50, February.
    7. Slade, Margaret E, 1995. "Product Rivalry with Multiple Strategic Weapons: An Analysis of Price and Advertising Competition," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 4(3), pages 445-76, Fall.
    8. Gasmi, F & Laffont, J J & Vuong, Q, 1992. "Econometric Analysis of Collusive Behavior in a Soft-Drink Market," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 1(2), pages 277-311, Summer.
    9. Abhik Roy & Dominique M. Hanssens & Jagmohan S. Raju, 1994. "Competitive Pricing by a Price Leader," Management Science, INFORMS, vol. 40(7), pages 809-823, July.
    10. Kadiyali, Vrinda & Vilcassim, Naufel J & Chintagunta, Pradeep K, 1996. "Empirical Analysis of Competitive Product Line Pricing Decisions: Lead, Follow, or Move Together?," The Journal of Business, University of Chicago Press, vol. 69(4), pages 459-87, October.
    11. S. Chan Choi, 1991. "Price Competition in a Channel Structure with a Common Retailer," Marketing Science, INFORMS, vol. 10(4), pages 271-296.
    12. Steven T. Berry, 1994. "Estimating Discrete-Choice Models of Product Differentiation," RAND Journal of Economics, The RAND Corporation, vol. 25(2), pages 242-262, Summer.
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