Bias from ignoring price dispersion in demand estimation

Abstract

Consumers often pay different prices for the same product bought in the same store at the same time. However, the demand estimation literature has ignored that fact using, instead, aggregate measures such as the 'list' or average price. In this paper we show that this will lead to biased price coefficients. Furthermore, we perform simple comparative statics simulation exercises for the logit and random coefficient models. In the 'list' price case we find that the bias is larger when discounts are higher, proportion of consumers facing discount prices is higher and when consumers are more unwilling to buy the product so that they almost only do it when facing discount. In the average price case we find that the bias is larger when discounts are higher, proportion of consumers that have access to discount are similar to the ones that do not have access and when consumers willingness to buy is very dependent on idiosyncratic shocks. Also bias is less problematic in the average price case in markets with a lot of bargain deals, so that prices are as good as individual. We conclude by proposing ways that the econometrician can reduce this bias using different information that he may have available.