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Unobserved Product Differentiation in Discrete-Choice Models: Estimating Price Elasticities and Welfare Effects

  • Daniel A. Ackerberg

    ()

    (University of California at Los Angeles)

  • Marc Rysman

    ()

    (Boston University)

Commonly used discrete-choice models such as logit, nested logit, and random-coefficients models place very strong restrictions on how unobservable characteristic space changes with the number of products. We argue (and show with Monte Carlo experiments)that these restrictions can lead to biased estimates of price elasticities and the welfare consequences from additional products. In addition, these restrictions can identify parameters that are not intuitively identified given the data at hand. We suggest an alternative model that does not have these properties and present a structural interpretation of the model. Monte Carlo experiments and an empirical example show that this issue can be important in practice.

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Article provided by The RAND Corporation in its journal RAND Journal of Economics.

Volume (Year): 36 (2005)
Issue (Month): 4 (Winter)
Pages: 771-788

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Handle: RePEc:rje:randje:v:36:y:2005:4:p:771-788
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  1. Benkard, C. Lanier & Bajari, Patrick, 2001. "Demand Estimation with Heterogeneous Consumers and Unobserved Product Characteristics: A Hedonic Approach," Research Papers 1691, Stanford University, Graduate School of Business.
  2. Steven Berry & Joel Waldfogel, 1996. "Free Entry and Social Inefficiency in Radio Broadcasting," NBER Working Papers 5528, National Bureau of Economic Research, Inc.
  3. Aviv Nevo, 1998. "Measuring Market Power in the Ready-to-Eat Cereal Industry," NBER Working Papers 6387, National Bureau of Economic Research, Inc.
  4. Patrick Bajari & C. Lanier Benkard, 2001. "Demand Estimation With Heterogeneous Consumers and Unobserved Product Characteristics: A Hedonic Approach," Working Papers 01010, Stanford University, Department of Economics.
  5. Marc Rysman, 2004. "Competition Between Networks: A�Study of the Market for Yellow�Pages," Review of Economic Studies, Wiley Blackwell, vol. 71(2), pages 483-512, 04.
  6. Feenstra, Robert C & Levinsohn, James A, 1995. "Estimating Markups and Market Conduct with Multidimensional Product Attributes," Review of Economic Studies, Wiley Blackwell, vol. 62(1), pages 19-52, January.
  7. Cardell, N. Scott, 1997. "Variance Components Structures for the Extreme-Value and Logistic Distributions with Application to Models of Heterogeneity," Econometric Theory, Cambridge University Press, vol. 13(02), pages 185-213, April.
  8. 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.
  9. Berry, Steven & Levinsohn, James & Pakes, Ariel, 1995. "Automobile Prices in Market Equilibrium," Econometrica, Econometric Society, vol. 63(4), pages 841-90, July.
  10. Patrick Bajari & C. Lanier Benkard, 2001. "Demand Estimation With Heterogeneous Consumers and Unobserved Product Characteristics: A Hedonic Approach," NBER Technical Working Papers 0272, National Bureau of Economic Research, Inc.
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