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Estimating demand elasticities in a differentiated product industry: the personal computer market

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  • Joanna Stavins

Abstract

Supply and demand functions are typically estimated using uniform prices and quantities across products, but where products are heterogeneous, it is important to consider quality differences explicitly. This paper demonstrates a new approach to doing this by employing hedonic coefficients to estimate price elasticities for differentiated products in the market for personal computers. Differences among products are modeled as distances in a linear quality space derived from a multi-dimensional attribute space. Heterogeneous quality allows for the estimation of varying demand elasticities among models, using models' relative positions as measures of market power. Instead of restricting market competition to the two nearest models, as is typically done in the differentiated-product literature, cross-elasticities of substitution are allowed to decline continuously with distance between models in quality space. Using data on prices, technical attributes, and shipments of personal computers sold in the United States from 1977 to 1988, two-stage least squares estimates of demand elasticities are obtained. The estimated elasticities vary across models and over time, and are consistent with observed changes in market structure. Entrant firms, as well as new models, are found to face more elastic demand. The estimated elasticities are used to calculate price-cost markups and industry profit-revenue ratios. Both measures decline significantly, indicating a decrease in industry profitability over time, as the market became more competitive.

Suggested Citation

  • Joanna Stavins, 1995. "Estimating demand elasticities in a differentiated product industry: the personal computer market," Working Papers 95-9, Federal Reserve Bank of Boston.
  • Handle: RePEc:fip:fedbwp:95-9
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    References listed on IDEAS

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    1. Robert C. Feenstra & James A. Levinsohn, 1995. "Estimating Markups and Market Conduct with Multidimensional Product Attributes," Review of Economic Studies, Oxford University Press, vol. 62(1), pages 19-52.
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    5. Rosen, Sherwin, 1974. "Hedonic Prices and Implicit Markets: Product Differentiation in Pure Competition," Journal of Political Economy, University of Chicago Press, vol. 82(1), pages 34-55, Jan.-Feb..
    6. James Levinsohn, 1988. "Empirics of Taxes on Differentiated Products: The Case of Tariffs in the U.S. Automobile Industry," NBER Chapters,in: Trade Policy Issues and Empirical Analysis, pages 9-44 National Bureau of Economic Research, Inc.
    7. Bresnahan, Timothy F., 1989. "Empirical studies of industries with market power," Handbook of Industrial Organization,in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 2, chapter 17, pages 1011-1057 Elsevier.
    8. Gelfand, Matthew D. & Spiller, Pablo T., 1987. "Entry barriers and multiproduct oligopolies: Do they forebear or spoil?," International Journal of Industrial Organization, Elsevier, vol. 5(1), pages 101-113, March.
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    Cited by:

    1. Timothy F. Bresnahan & Scott Stern & Manuel Trajtenberg, 1995. "Market Segmentation and the Sources of Rents from Innovation: Personal Computers in the Late 1980s," Working Papers 95001, Stanford University, Department of Economics.
    2. repec:pal:jorsoc:v:56:y:2005:i:11:d:10.1057_palgrave.jors.2601956 is not listed on IDEAS
    3. Hyunbae Chun & M. Ishaq Nadiri, 2008. "Decomposing Productivity Growth in the U.S. Computer Industry," The Review of Economics and Statistics, MIT Press, vol. 90(1), pages 174-180, February.
    4. Lau, Amy Hing Ling & Lau, Hon-Shiang, 2005. "Some two-echelon supply-chain games: Improving from deterministic-symmetric-information to stochastic-asymmetric-information models," European Journal of Operational Research, Elsevier, vol. 161(1), pages 203-223, February.
    5. Ibon Galarraga & David Heres Del Valle & Mikel González-Eguino, 2011. "Price Premium for High-Efficiency Refrigerators and Calculation of Price-Elasticities for Close-Substitutes: Combining Hedonic Pricing and Demand Systems," Working Papers 2011-07, BC3.
    6. repec:pal:jorsoc:v:58:y:2007:i:4:d:10.1057_palgrave.jors.2602167 is not listed on IDEAS
    7. Flavio M. Menezes & Marcin Pracz & Rod Tyers, 2007. "Strategic Interaction amongst Australia's East Coast Ports," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, pages 267-278.
    8. Gretz, Richard T., 2010. "Hardware quality vs. network size in the home video game industry," Journal of Economic Behavior & Organization, Elsevier, vol. 76(2), pages 168-183, November.
    9. Timothy F. Bresnahan & Scott Stern & Manuel Trajtenberg, 1995. "Market Segmentation and the Sources of Rents from Innovation: Personal Computers in the Late 1980s," Working Papers 95001, Stanford University, Department of Economics.
    10. Fleischmann, M. & Hall, J.M. & Pyke, D.F., 2005. "A Dynamic Pricing Model for Coordinated Sales and Operations," ERIM Report Series Research in Management ERS-2005-074-LIS, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    11. Galarraga, Ibon & González-Eguino, Mikel & Markandya, Anil, 2011. "Willingness to pay and price elasticities of demand for energy-efficient appliances: Combining the hedonic approach and demand systems," Energy Economics, Elsevier, vol. 33(S1), pages 66-74.
    12. Lau, Amy Hing Ling & Lau, Hon-Shiang, 2003. "Effects of a demand-curve's shape on the optimal solutions of a multi-echelon inventory/pricing model," European Journal of Operational Research, Elsevier, vol. 147(3), pages 530-548, June.

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    Keywords

    Computers ; Prices ; Supply and demand;

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