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Estimating demand elasticities in a differentiated product industry: the personal computer market

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  • Joanna Stavins

Abstract

Supply and demand functions are typically estimated using uniform prices and quantities across products, but where products are heterogeneous, it is important to consider quality differences explicitly. This paper demonstrates a new approach to doing this by employing hedonic coefficients to estimate price elasticities for differentiated products in the market for personal computers. Differences among products are modeled as distances in a linear quality space derived from a multi-dimensional attribute space. Heterogeneous quality allows for the estimation of varying demand elasticities among models, using models' relative positions as measures of market power. Instead of restricting market competition to the two nearest models, as is typically done in the differentiated-product literature, cross-elasticities of substitution are allowed to decline continuously with distance between models in quality space. Using data on prices, technical attributes, and shipments of personal computers sold in the United States from 1977 to 1988, two-stage least squares estimates of demand elasticities are obtained. The estimated elasticities vary across models and over time, and are consistent with observed changes in market structure. Entrant firms, as well as new models, are found to face more elastic demand. The estimated elasticities are used to calculate price-cost markups and industry profit-revenue ratios. Both measures decline significantly, indicating a decrease in industry profitability over time, as the market became more competitive.

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  • Joanna Stavins, 1995. "Estimating demand elasticities in a differentiated product industry: the personal computer market," Working Papers 95-9, Federal Reserve Bank of Boston.
  • Handle: RePEc:fip:fedbwp:95-9
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    Cited by:

    1. Timothy F. Bresnahan & Scott Stern & Manuel Trajtenberg, 1995. "Market Segmentation and the Sources of Rents from Innovation: Personal Computers in the Late 1980s," Working Papers 95001, Stanford University, Department of Economics.
    2. A H L Lau & H-S Lau, 2005. "A critical comparison of the various plausible inter-echelon gaming processes in supply chain models," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 56(11), pages 1273-1286, November.
    3. repec:diw:diwwpp:dp148 is not listed on IDEAS
    4. Ibon Galarraga & David Heres Del Valle & Mikel González-Eguino, 2011. "Price Premium for High-Efficiency Refrigerators and Calculation of Price-Elasticities for Close-Substitutes: Combining Hedonic Pricing and Demand Systems," Working Papers 2011-07, BC3.
    5. A H L Lau & H-S Lau & J-C Wang, 2007. "Some properties of buyback and other related schemes in a newsvendor-product supply chain with price-sensitive demand," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 58(4), pages 491-504, April.
    6. Christos Genakos & Kai‐Uwe Kühn & John Van Reenen, 2018. "Leveraging Monopoly Power by Degrading Interoperability: Theory and Evidence from Computer Markets," Economica, London School of Economics and Political Science, vol. 85(340), pages 873-902, October.
    7. Gretz, Richard T. & Basuroy, Suman, 2013. "Why Quality May Not Always Win: The Impact of Product Generation Life Cycles on Quality and Network Effects in High-tech Markets," Journal of Retailing, Elsevier, vol. 89(3), pages 281-300.
    8. KHAN, Muhammad Arshad, 2008. "Long-Run And Short-Run Dynamics Of Foreign Exchange Reserves Flows And Domestic Credit In Pakistan," International Journal of Applied Econometrics and Quantitative Studies, Euro-American Association of Economic Development, vol. 5(1), pages 61-78.
    9. Marcin Pracz & Rod Tyers, 2006. "Strategic Interaction amongst Australia’s East Coast Ports," ANU Working Papers in Economics and Econometrics 2006-471, Australian National University, College of Business and Economics, School of Economics.
    10. Lau, Amy Hing Ling & Lau, Hon-Shiang, 2003. "Effects of a demand-curve's shape on the optimal solutions of a multi-echelon inventory/pricing model," European Journal of Operational Research, Elsevier, vol. 147(3), pages 530-548, June.
    11. Osborne Jackson & Thu Tran, 2020. "Larceny in the Product Market: A Hidden Tax?," Working Papers 20-14, Federal Reserve Bank of Boston.
    12. Hyunbae Chun & M. Ishaq Nadiri, 2008. "Decomposing Productivity Growth in the U.S. Computer Industry," The Review of Economics and Statistics, MIT Press, vol. 90(1), pages 174-180, February.
    13. Lau, Amy Hing Ling & Lau, Hon-Shiang, 2005. "Some two-echelon supply-chain games: Improving from deterministic-symmetric-information to stochastic-asymmetric-information models," European Journal of Operational Research, Elsevier, vol. 161(1), pages 203-223, February.
    14. Gretz, Richard T., 2010. "Hardware quality vs. network size in the home video game industry," Journal of Economic Behavior & Organization, Elsevier, vol. 76(2), pages 168-183, November.
    15. Fleischmann, M. & Hall, J.M. & Pyke, D.F., 2005. "A Dynamic Pricing Model for Coordinated Sales and Operations," ERIM Report Series Research in Management ERS-2005-074-LIS, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    16. Galarraga, Ibon & González-Eguino, Mikel & Markandya, Anil, 2011. "Willingness to pay and price elasticities of demand for energy-efficient appliances: Combining the hedonic approach and demand systems," Energy Economics, Elsevier, vol. 33(S1), pages 66-74.

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