Logit demand estimation under competitive pricing behavior: An equilibriumframework

Discrete choice models of demand have typically been estimated assuming tha t prices are exogenous. Since unobservable (to the researcher) product attr ibutes, such as coupon availability, may impact consumer utility as well as price setting by firms, we treat prices as endogenous. Specifically, price s are assumed to be the equilibrium outcomes of Nash competition among manu facturers and retailers. To empirically validate the assumptions, we estima te legit demand systems jointly with equilibrium pricing equations for two product categories using retail scanner data and cost data on factor prices . In each category, we find statistical evidence of price endogeneity. We a lso find that the estimates of the price response parameter and the brand-s pecific constants are generally biased downward when the endogeneity of pri ces is ignored. Our framework provides explicit estimates of the value crea ted by a brand, i.e., the difference between consumers' willingness to pay for a brand and its cost of production. We develop theoretical propositions about the relationship between value creation and competitive advantage fo r legit demand systems and use our empirical results to illustrate how firm s use alternative value creation strategies to accomplish competitive advan tage.