(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 167

142 PART • Producers, Consumers, and Competitive Markets The specification and estimation of demand curves has been a rapidly growing endeavor, not only in marketing, but also in antitrust analyses It is now commonplace to use estimated demand relationships to evaluate the likely effects of mergers.12 What were once prohibitively costly analyses involving mainframe computers can now be carried out in a few seconds on a personal computer Accordingly, governmental competition authorities and economic and marketing experts in the private sector make frequent use of supermarket scanner data as inputs for estimating demand relationships Once the price elasticity of demand for a particular product is known, a firm can decide whether it is profitable to raise or lower price Other things being equal, the lower in magnitude the elasticity, the more likely the profitability of a price increase EXAMPLE THE DEMAND FOR READY-TO-EAT CEREAL The Post Cereals division of Kraft General Foods acquired the Shredded Wheat cereals of Nabisco in 1995 The acquisition raised the legal and economic question of whether Post would raise the price of its best-selling brand, Grape Nuts, or the price of Nabisco’s most successful brand, Shredded Wheat Spoon Size.13 One important issue in a lawsuit brought by the state of New York was whether the two brands were close substitutes for one another If so, it would be more profitable for Post to increase the price of Grape Nuts (or Shredded Wheat) after rather than before the acquisition Why? Because after the acquisition the lost sales from consumers who switched away from Grape Nuts (or Shredded Wheat) would be recovered to the extent that they switched to the substitute product The extent to which a price increase will cause consumers to switch is given (in part) by the price elasticity of demand for Grape Nuts Other things being equal, the higher the demand elasticity, the greater the loss of sales associated with a price increase The more likely, too, that the price increase will be unprofitable The substitutability of Grape Nuts and Shredded Wheat can be measured by the cross-price elasticity of demand for Grape Nuts with respect to the price of Shredded Wheat The relevant elasticities were calculated using weekly data obtained from supermarket scanning of household purchases for 10 cities over a three-year period One of the estimated isoelastic demand equations appeared in the following log-linear form: log(QGN) = 1.998 - 2.085 log(PGN) + 0.62 log(I) + 0.14 log(PSW) where QGN is the amount (in pounds) of Grape Nuts sold weekly, PGN the price per pound of Grape Nuts, I real personal income, and PSW the price per pound of Shredded Wheat Spoon Size The demand for Grape Nuts is elastic (at current prices), with a price elasticity of about -2 The income elasticity is 0.62: In other words, increases in income lead to increases in cereal purchases, but at less than a 1-for-1 rate Finally, the cross-price elasticity is 0.14 This figure is consistent with the fact that although the two cereals are substitutes (the quantity demanded of Grape Nuts increases in response to an increase in the price of Shredded Wheat), they are not very close substitutes 12 See Jonathan B Baker and Daniel L Rubinfeld, “Empirical Methods in Antitrust Litigation: Review and Critique,” American Law and Economics Review, 1(1999): 386–435 13 State of New York v Kraft General Foods, Inc., 926 F Supp 321, 356 (S.D.N.Y 1995)