Berry-Levensohn-Pakes EMA (1995) Paper Notes

ECON 721

Goals of paper

• To estimate demand and cost parameters for a class of oligopolistic differentiated products markets– Demand side – recover own and cross price

elasticities and elasticities with respect to product attributes

– Supply side – recover cost as a function of product characteristics

• Method uses product-level and aggregate consumer-level data

• Estimation is consistent with a structural model of equilibrium in an oligopolistic industry

Key features of the modeling framework

• Joint distribution of consumer characteristics and product attributes that determines preferences over the products marketed

• Price taking on the part of the consumers• Nash equilibrium assumptions on the behavior of

producers in an oligopolistic, differentiated product market (new car market)

Notation

• ζ : characteristics of the individual making the choice

• (x,ξ,p): product characteristics (observed, unobserved and price)– ξ represents for example style, prestige, reputation

• U(ζi,pj,xj, ξj ;θ ) = utility if person i makes choice j

• Choice 0 is the outside option of not purchasing any of the goods (cars)

• If M is the number of consumers in the market, then the vector of market demands is given by

iid case, with no unobserved product heterogeneity

• Model not that appealing– subject to IIA criticism– Does not allow for interaction between

consumer and product-level characteristics (no preference heterogeneity)

– Substitution patterns only depend on the δ’s. Conditional on market shares, substitution patterns do not depend on attributes of the products

• Therefore, generalize the model to allow consumers to have different preferences for different observable characteristics (random coefficients model)

• Have information on aggregate distribution of consumer’s income, that they want to incorporate– Income distribution will come from CPS, not car data

• Final specification (Cobb-Douglas form):

• Price is expected to be correlated with unobserved product attributes ξ – need instruments

• Will estimate demand system by Method of Moments, jointly with supply side

• Quantity demanded

• Use an inversion procedure of Berry (1994) to transform the observed quantity, price and characteristics data into a linear function of ξ

Cost side

• Multiproduct firms 1…F• Each produces a subset of J possible products (car manufacturers

produce multiple types of cars that may compete with each other)• Cost of producing a product is assumed to be independent of output

levels and log linear in vector of cost characteristics (wj,ωj)

Nash assumption

• Firm chooses prices that maximize profit-taking, given the attributes of its products and the prices and attributes of competitor’s products

• Only price is endogenous to the model, attributes are not endogenous (do not decide what types of cars to bring to market)

FOC

instruments

• Assume – E(ωj |z)=0

– E(ξj |z)=0

• Instrument set consists of functions of the characteristics and cost shifters of all other products

Empirical Results

• Use data from the Automotive News Market Data Book– Number of cylinders, number of doors, weight, engine

displacement, horsepower, length, width, wheelbase, EPA MPG, front wheel drive, automatic transmission, power steering, air conditioning