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Discrete Choice Models as Structural Models of Demand: Some Economic Implications of Common Approaches

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  • Patrick Bajari
  • Lanier Benkard

Abstract

October 2001 We derive some theoretical economic properties of standard discrete choice econometric models that we believe are undesirable if the models are to be used as structural models of demand. We show that many standard models have the following properties: as the number of products increases, the compensating variation for removing all of the inside goods tends to infinity, all firms in Bertrand-Nash pricing game have markups that are bounded away from zero, and for each good there is always some consumer that is willing to pay an arbitrarily large sum for the good. These undesirable properties may lead to incorrect conclusions about many policies of interest, including calculation of price indexes, the benefits of new goods, and the welfare loss due to mergers. We demonstrate that these undesirable properties hold not only in the logit model, but also in all random utility models with the following three general properties: 1) the model includes an additive error term whose conditional support is unbounded, 2) the deterministic part of the utility function satisfies standard continuity and monotonicity conditions, and 3) the hazard rate of the error distribution is bounded above. One approach to avoiding these undesirable properties is to weaken these three restrictions. However, we also show that random utility models are not in general non-parametrically identified from market shares or individual level choice data. Our findings support the use of alternative structural approaches that have better economic properties, such as those of Bajari and Benkard (2001) and Berry and Pakes (2000). Working Papers Index

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  • Patrick Bajari & Lanier Benkard, 2001. "Discrete Choice Models as Structural Models of Demand: Some Economic Implications of Common Approaches," Working Papers 01016, Stanford University, Department of Economics.
  • Handle: RePEc:wop:stanec:01016
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    1. Daniel A. Ackerberg & Marc Rysman, 2005. "Unobserved Product Differentiation in Discrete-Choice Models: Estimating Price Elasticities and Welfare Effects," RAND Journal of Economics, The RAND Corporation, vol. 36(4), pages 771-788, Winter.
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    5. ANDERSON, Simon P. & de PALMA, André & THISSE, Jacques-François, 1992. "Interpretations of the logit discrete choice models and the theory of product differentiation," LIDAM Reprints CORE 1017, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    6. Peter Davis, 2006. "Spatial competition in retail markets: movie theaters," RAND Journal of Economics, RAND Corporation, vol. 37(4), pages 964-982, December.
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    Cited by:

    1. Donghun Kim, 2004. "Estimation of the Effects of New Brands on Incumbents’ Profits and Consumer Welfare: The U.S. Processed Cheese Market Case," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 25(3), pages 275-293, September.
    2. Dhar, Tirtha & Chavas, Jean-Paul & Cotterill, Ronald W. & Gould, Brian W., 2002. "An Econometric Analysis of Brand Level Strategic Pricing Between Coca Cola and Pepsi Inc," Working Papers 201553, University of Wisconsin-Madison, Department of Agricultural and Applied Economics, Food System Research Group.
    3. Sofia B. Villas‐Boas & Céline Bonnet & James Hilger, 2021. "Random Utility Models, Wine and Experts," American Journal of Agricultural Economics, John Wiley & Sons, vol. 103(2), pages 663-681, March.
    4. Saxell, Tanja, 2014. "Industrial organization studies on pharmaceutical markets," Research Reports P65, VATT Institute for Economic Research.
    5. Saxell, Tanja, 2014. "Industrial organization studies on pharmaceutical markets," Research Reports 65, VATT Institute for Economic Research.

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