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Demand Estimation Has Been At The Heart Of Many Studies

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Literature Review Demand estimation has been at the heart of many studies that focus on questions regarding market power, merger and acquisition, research and innovation and valuation of new brands in differentiated-products industries. Under the framework of demand estimation, Bresnahan (1987) constructs equilibrium models of oligopoly under product differentiation and studies the competition and collusion in the 1995 price war in the American automobile industry. Gasmi, Laffont and Vuong (1992) study the collusive behavior on price and advertising in the U.S. soft-drink market, which is dominated by Coca-Cola and Pepsi-Cola, after obtaining a full information maximum likelihood estimation of demand functions. Hausman, Leonard and Zona…show more content…
Firstly, there would be a large number of parameters to be estimated. For example, in a log-log demand system, where logarithms of quantities are linear functions of logarithms of all prices, without additional restrictions, we would have 10,000 parameters if there were 100 differentiated products in the market. The second concern introduced when doing demand estimation for differentiated product is the heterogeneity in consumer tastes. Dixit and Stiglizt (1997) suggest a representative consumer approach to deal with this. They assume that consumer preferences are of the right form so that an average consumer exists; there exists a demand system that lends itself to the level of differentiation observed in the marketplace. However, the required assumptions are strong and empirically false for many applications (Nevo, 2000). The above two problems are addressed by logit demand model (McFadden, 1973). The logit model solves dimensionality problem by projecting the products onto a space of characteristics; in this way, the dimension of the attribute space instead of the square of the number of products becomes the relevant size. However, due to the restrictive way of modeling heterogeneity and the property of independence from irrelevant alternatives (IIA property) in the logit model, substitution pattern between products is driven completely by
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