Retail Market Power in a Shopping Basket Model of Supermarket Competition

Supermarket consumers typically purchase more than one item ata time. Modeling demand relationship among items in consumers' shopping baskets is therfore essential to understanding how retailers set prices. To date, models of price competition among retailers typically assume consumers make discrete choices among categories in the store or derive utility from independent goods that is unaffected by basket composition. In this paper, we develop a model of price competition among items in consumer shopping baskets. We derive inferences for market power under complementary categories and compare outcomes with the prediction of models that assume discrete choice among independent categories. We show that complementarity generates substantially greater pricing power for retailers than independent goods, resulting in less competitive behavior.