Abstract
This article examines the potential quality bias in price elasticities in cross-sectional demand analysis and develops a framework that can be used to avoid this problem. Both analytical and empirical results indicate that ignoring quality adjustment in either prices or quantities can cause biased price elasticities, which may lead to erroneous marketing decisions and policy implications.
Acknowledgements
The author is grateful to Todd M. Schmit for research assistance, to Brian W. Gould for providing data, and Tracy Boyer for comments.
Notes
1 Hick's composite commodity theorem states that if prices of individual goods move in parallel, then the corresponding group of goods can be treated as a single commodity (Deaton and Muellbauer, Citation1993, p. 121).
2 The denominator of Equation 5 is derived by differentiating Equation 4 with respect to lnPc , and ∂lnLc /∂lnPc is derived from the demand function for the elementary good xi . By assuming weak separability, the vector of elementary good demand, x, can be written as a function of total expenditures on composite commodity c and the price vector of elementary goods that comprise the composite commodity c. Since the demand functions of these elementary goods are homogeneous of degree zero in total expenditures and prices, the vector of individual goods’ demand x can be represented by:
3 Differentiating Equation 4 with respect to lnM results in:
4 Regression results of Equations Equation13 and Equation14 and detailed procedure to obtain price elasticities have been suppressed due to the space limitation. However, this information is available from the author upon request.