Learning to Set Prices in the Washington State Liquor Market
63 Pages Posted: 9 Nov 2018
Date Written: October 8, 2018
How do new entrants learn about demand and adapt to new market conditions? We study retail prices in the Washington State liquor market where privatization led existing grocery chains to enter this market for the first time. We document large price changes across a broad range of products and provide novel evidence showing that these changes result from retailers learning about demand: prices absorb realized demand shocks, adjusting to better reflect demand primitives. We then estimate a structural model that imposes minimal assumptions on the optimality of observed prices. Comparing against the full-information optimal prices implied by the model, we find that learning continues to occur even years after entering the new market, and the limited demand information initially causes up to 13% lower profit compared to full information. Further, empirical pricing patterns suggest that retailers learn about both levels and the slope of demand, and learn from both own experience and practices of others.
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