Title: The Kinked Demand Curve and Price Rigidity: Evidence from Scanner Data
1The Kinked Demand Curve and Price Rigidity
Evidence from Scanner Data
- Maarten Dossche
- (Ghent University National Bank of Belgium)
- Freddy Heylen
- (Ghent University, Sherppa)
- Dirk Van den Poel
- (Ghent University, Department of Marketing)
- Paper presented at the Conference on Price and
Wage Rigidities in an Open Economy, National Bank
of Belgium, October 2006
2Presentation Outline
- Broader context and motivation introducing the
kinked demand curve - Basic facts about our data
- Econometric model the Almost Ideal Demand
System (Deaton-Muellbauer, 1980) and beyond - Empirical analysis
- Econometric issues and specification
- Empirical results price elasticity and
curvature - Conclusions
3Broader context and motivation
Persistent effects of monetary shocks on real
output and inflation. (Christiano et al.,1999,
2005 Peersman, 2004.). The key role of price
rigidity
- Frictions to nominal price adjustment (Taylor,
1980 Calvo, 1983 - Mankiw, 1985)
- Real wage rigidity (Ball-Romer,1990
Blanchard-Galí, 2006.).
- Firm specific factors of production and a high
price elasticity - of demand (Galí-Gertler, 1999 Woodford, 2003
Altig et al., 2005)
- The kinked (concave) demand curve
4Introducing the kinked demand curve
Constant price elasticity of demand
(Dixit-Stiglitz, 1977)
? 3
price elasticity of demand
5Introducing the kinked demand curve
The kinked (concave) demand curve (Kimball, 1995)
6Introducing the kinked demand curve
The kinked (concave) demand curve (Kimball, 1995)
7Introducing the kinked demand curve
8Introducing the kinked demand curve
- Our contribution
- Does the kinked demand curve exist?
- Estimate the price elasticity of demand and
especially - its curvature
Allow for flexibility
? 3
9Presentation Outline
- Broader context and motivation introducing the
kinked demand curve - Basic facts about our data
- Econometric model the Almost Ideal Demand
System (Deaton-Muellbauer, 1980) and beyond - Empirical analysis
- Econometric issues and specification
- Empirical results price elasticity and
curvature - Conclusions
10Basic facts about the data
- Anonymous euro area supermarket, sample 6 outlets
- In our sample 2274 items from 58 product
categories - Detailed transaction records prices and
quantities - Bi-weekly observations, January 2002 April 2005
- Prices are predetermined and equal in each outlet
- Analysis of
- Size and frequency of price adjustment
- Importance of demand and supply shocks
- Asymmetry in demand sensitivity to price changes
11Basic facts nominal price adjustment
- Prices are predetermined
- High frequency of temporary price markdowns
- Price adjustment statistics
In between existing studies on US and Euro area
12Presentation Outline
- Broader context and motivation introducing the
kinked demand curve - Basic facts about our data
- Econometric model the Almost Ideal Demand
System (Deaton-Muellbauer, 1980) and beyond - Empirical analysis
- Econometric issues and specification
- Empirical results price elasticity and
curvature - Conclusions
13Econometric model The Almost Ideal Demand System
(Deaton and Muellbauer, 1980)
- Very good properties for our purpose
- Flexible with respect to estimating price
elasticities - Simple, transparent, easy to estimate for a large
number of product categories - Most appropriate in a setup (like ours) where
consumers may buy different items of given
product categories - Not necessary to specify the characteristics of
all goods
Other models, e.g. mixed logit model (Berry et
al., 1995)
Still, the AIDS is not flexible enough
14Econometric model The Almost Ideal Demand System
(Deaton and Muellbauer, 1980)
The AIDS model is not flexible enough (see below)
- Curvature is a very restrictive function of price
elasticity - Negative curvature (convex demand) is almost
impossible
A behavioral extension of the AIDS model
- AIDS describes optimal behavior assuming
indifference surface to be given, only captures
standard substitution and income effects of price
changes. - Extension allow for changes in indifference
surface when price deviates from a reference
price (Tversky-Kahneman, Okun, Rotemberg,)
15Econometric model The Almost Ideal Demand System
(Deaton and Muellbauer, 1980)
Behavioral extension of the AIDS model
for i 1,.. N (goods) and t 1,. T (time
periods)
16Econometric model The Almost Ideal Demand System
(Deaton and Muellbauer, 1980)
?(Positive) own price elasticity of demand
In steady state
Elasticity can vary in relative price !
17Econometric model micro foundations
? Curvature of demand function
- Note ! Without our extension, the curvature
- is a direct function of the estimated price
elasticity - is almost unavoidably positive (for positive
price elasticity) - (beta is very close to zero)
18Presentation Outline
- Broader context and motivation introducing the
kinked demand curve - Basic facts about our data
- Econometric model the Almost Ideal Demand
System (Deaton-Muellbauer, 1980) and beyond - Empirical analysis
- Econometric issues and specification
- Empirical results price elasticity and
curvature - Conclusions
19Identification / Estimation
i 1,5 (goods) m 1,.6 (outlets)
t 1,.. 86 (time periods) Cjt circular
(folder) dummy ??it time dummy for public
holiday
Impose standard restrictions (homogeneity in
prices, symmetry, adding up)
20Identification / Estimation
Estimation method SUR Motivation pit is
uncorrelated to the error term ?imt
- Prices are predetermined and equal over all 6
outlets - Predictable demand shocks and item specific
characteristics that - may affect prices are captured by time dummies
and fixed effects (they - do not show in the error term)
- Robustness test later supports our choice for
SUR.
21Estimation results (histogram)
N.Obs. 666
Median 1.4
22Estimation results (histogram)
N.Obs. 666
Median 0.8 / About 40 of estimated
curvatures are negative.
23Estimation results
24Estimation results
- Considering existing literature
- empirical studies on the price elasticity of
demand (Bijmolt et al., 2005) - Industrial organization studies of price-cost
mark-ups (Domowitz et al., 1988 Konings et al.,
2001 Dobbelaere, 2004) - Price elasticity of demand is between 3 and 6.
Our conclusion curvature is around 4.
25Estimation results
26Conclusions
- Evidence supports the kinked (concave) demand
curve in macro models
- Sensible curvature value is 4
- Significant fraction of products negative
curvature (convex demand) ? two sector models?
- No correlation between price elasticity /
curvature and the size or frequency of price
adjustment
27Estimation results robustness
- Re-estimation of the model using an IV-method
(3SLS). Since cost data are lacking and prices
are equal across outlets, we use lagged prices as
instruments for pit .
- Introduction of more time dummies (seasonal
dummies) to capture additional possible demand
shifts.
- Allow for gradual demand adjustment to price
changes by adding a lagged dependent variable of
the model.
Highly similar results, conclusions unaffected.