An Estimable Model of Supermarket Behavior: Prices, Distribution Services and Some Effects of Competition

Abstract

In this paper we present and estimate a simple model of supermarket behavior that has several attractive properties: It permits the incorporation of the (distribution) services provided by a supermarket as an output of supermarkets and a determinant of demand for supermarket products; it generates, as a special case, one of its main competitors in the supermarket literature – the so called full price model of services; and, it can be estimated with a unique data set originally constructed by the Economic Research Service of USDA. The main results of the analysis are three. First, the aggregate demand for a supermarket's products depends critically on distribution services: at the substantive level, a 1% increase in these services increase quantity demanded by 0.4%; at the methodological level, the restrictions on the parameter values implied by the model are critical in the evaluation of functional forms for demand. Second, supermarkets exhibit constant marginal costs with respect to the quantity of output or turnover and substantially declining marginal costs with respect to (distribution) services, which implies substantial multiproduct economies of scale. Third, in response to an exogenous increase in competition those supermarkets that have adopted newer formats such as superstores and that employ newer technology such as optical scanners choose prices and (distribution ) services in ways that increase consumer welfare, whereas those that do not have these characteristics choose prices and services in ways that lower consumer welfare.