CAREER: Empirical Studies of Dynamics in Industrial Organization

University Of California-Berkeley, Berkeley CA

Investigators

Abstract

This proposal outlines an empirical research and teaching agenda for analyzing the economics of several dynamic phenomena, relevant to the study of Industrial Organization. The three research projects and educational activities studies are intended to improve our understanding of the specific industries involved and, more broadly, to help assess the relevance of a number of economic theories. The first two projects construct and estimate a dynamic model of consumer choice in order to study the effects of temporary prices reductions ("sales") and coupons, respectively. The third model studies brand introduction using a multi-agent model of industry dynamics. The educational component of this project proposes several activities that connect to the research projects. The first project focuses on temporal price reductions, so called "sales", which are a common practice in many industries. There are several potential explanations of sales, but here the focus is on intertemporal price discrimination. More specifically, the PI models the consumer's dynamic problem when she has an expected stream of future demands, is able to store a consumption good, at a cost, and faces price movements. In this model, the consumer will purchase the product either because she wants to consume in the current period or because she believes the difference between the current price and the expected future price is lower than the cost of storing the inventory. To the extent that the latter effect is important, it has implications for the use of demand elasticities, computed from a static demand model, in merger analysis, valuation of new goods, as well as other policy relevant issues. The PI uses data on the purchases of 1,000 households of 24 products over 104 weeks, in order to examine correlations implied by the model and to estimate the model directly. The focus of the second project is coupons, which economists generally consider as a textbook example of a price discrimination tool. In a recent paper Nevo and Wolfram (1999) suggest that in order to fully understand the economics of coupons, a model richer than the standard static monopoly theory is needed. They also find some evidence that the patterns of couponing are consistent with: (1) models of price discrimination in oligopoly settings, which suggest that coupons are mainly used to induce switching from competing brands, and (2) the use of coupons to promote repurchase. In order to examine these issues further, the PI constructs a dynamic model of consumer choice allowing for brand loyalty. The model is estimated using a combination of the coupon data used in Nevo and Wolfram (1999) and the household purchase data described in the first project. The third project focuses on firm dynamics. In previous work the PI studied price competition and mergers in the ready-to-eat cereal industry (Nevo, 2000a, b) using static models of competition, taking as given the brands offered by the firms. However, brand introduction is an important dimension in this industry, as well as in other industries. In this project the PI analyzes a multi-agent dynamic model, in which firms can introduce new brands, discontinue old brands and impact the perceived quality of their existing brands by investing. The investment, which can be thought of as advertising, yields a random outcome. The PI examines the Markov Perfect equilibrium of the model. The predictions of the model, under different assumptions, can be compared to actual brand introduction in order to better understand the brand introduction process. Furthermore, the model can be used to simulate the industry structure under different scenarios. The latter is particularly important to anti-trust policy in an era when innovation, rather than price fixing, seems to be the focus. In terms of education, the PI develops a graduate curriculum and student workshop, both of which will train students in the above methods, and more broadly assist them in writing a thesis in industrial organization. Finally, the proposal demonstrates how the proposed research can also feed into teaching and advising at the undergraduate level.