DECOMPOSING PURCHASE ELASTICITY WITH A DYNAMIC STRUCTURAL MODEL OF FLEXIBLE CONSUMPTION

It is well known that in package goods categories a temporary price cut of a brand leads to increase in the sales of that brand in the current period. Under the assumption of stable consumption rate, previous literature has identified that the sources for the increase in sales are brand switching, purchase acceleration, and increase in quantity. However, there are very few studies that have formally modeled the impact of price promotions on consumption when consumption rate in a category is not constant. In this paper we offer a methodology to decompose the effects of price promotions into brand switching, stockpiling and change in consumption and explicitly allow for consumer heterogeneity in brand preferences and consumption needs. A dynamic structural model of a household that decides when, what, how much to buy as well as how much to consume to maximize its expected utility over an infinite horizon is developed. By making certain simplifying assumptions we are able to reduce the dimensionality of the problem. We estimate the proposed model using a scanner panel data of 1000 households on canned tuna purchases for 12 product alternatives over a two-year period. The results from the model shed insights on the decomposition of the price elasticity into it