Pass-through and tax incidence in differentiated product markets

• Published in: International journal of industrial organization 2023-09, Vol.90, p.102985, Article 102985
• Main Authors: Miravete, Eugenio J., Seim, Katja, Thurk, Jeff
• Format: Article
• Language: English
• Subjects: Demand curvature; Market power; Pass-Through; Tax incidence
• ISSN: 0167-7187
• DOI: 10.1016/j.ijindorg.2023.102985

•We consider the forces that drive demand curvature in logit demand: the impact of outside-good spending on the consumer’s indirect utility and the heterogeneity in this response across consumers.•We use the canonical example of the ready-to-eat cereal market (Nevo 2000) to contrast elasticity and curvature estimates across several workhorse models of demand.•Our results are of relevance to the robust assessment of tax incidence and the pass-through of cost savings, such as from a horizontal merger, in differentiated product markets. The role of demand curvature in determining firm behavior in symmetric oligopolistic product markets is well-understood. We consider the empirically relevant discrete choice differentiated product demand and point to two forces that drive curvature in logit demand: the impact of outside-good spending on the consumer’s indirect utility and the heterogeneity in this response across consumers. We use the canonical example of the ready-to-eat cereal market (Nevo, 2000) to contrast elasticity and curvature estimates across several workhorse models. We illustrate that the log-concave Multinomial Logit and Nested Logit demands yield significantly biased curvature estimates. In contrast, a Mixed Logit specification generates a wider range of curvatures, including curvatures larger than one. These results are of immediate relevance to the robust assessment of tax incidence and the pass-through of cost savings, such as from a horizontal merger, in differentiated product markets.