Pricing Behavior in Markets with State-Dependence in Demand

48 Pages Posted: 29 Sep 2003

See all articles by Hai Che

Hai Che

University of California, Berkeley - Marketing Group; Indiana University - Kelley School of Business - Department of Marketing

Seethu Seetharaman

Washington University in St. Louis - John M. Olin Business School

K. Sudhir

Yale School of Management; Yale University-Department of Economics; Yale University - Cowles Foundation

Date Written: July 2003

Abstract

Marketing researchers have documented significant biases in estimated price elasticities from brand choice models that ignore state dependence effects. Yet empirical research on firm behavior has thus far ignored the effects of state dependence. In this paper we investigate the supply side consequences of ignoring state dependence using household-level data from the cereal category.

Our key results are as follows: We find evidence of both positive (i.e. inertia) and negative (i.e. variety-seeking) state dependence in the cereal category. Ignoring state dependence in demand biases inferences about firm behavior. Specifically, we attribute the observed prices in the cereal category to tacit collusion between manufacturers, when in fact accounting for the effects of state dependence shows that competitive behavior is indeed non-cooperative. We find that firms are forward looking in that they incorporate the effect of their current prices on future profits. However, the relative "bang for the buck," in terms of improvements in prediction and fit, is much greater from modeling state dependence in demand than from modeling inter-temporal firm behavior on the supply side.

Suggested Citation

Che, Hai and Seetharaman, Seethu and Sudhir, K., Pricing Behavior in Markets with State-Dependence in Demand (July 2003). Available at SSRN: https://ssrn.com/abstract=442580 or http://dx.doi.org/10.2139/ssrn.442580

Hai Che (Contact Author)

University of California, Berkeley - Marketing Group ( email )

Haas School of Business
Berkeley, CA 94720
United States
510-643-8918 (Phone)
510-643-1420 (Fax)

Indiana University - Kelley School of Business - Department of Marketing ( email )

Kelley School of Business
Bloomington, IN 47405
United States

Seethu Seetharaman

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

K. Sudhir

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-3289 (Phone)
203-432-3003 (Fax)

Yale University-Department of Economics ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States

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