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Consumer Choice and Market Expansion: Modeling, Optimization and Estimation

Market size, measured by the number of people who are interested in products from the same category, may be highly influenced by assortment planning and pricing decisions. This effect is referred to as market expansion. In this paper, we incorporate the market expansion effects into consumer choice models and investigate assortment and pricing problems. In particular, we take the widely used multinomial logit model as a showcase to examine the market expansion effects on assortment planning and pricing, and also propose an alternating-optimization expectation-maximization method, which separates the estimation of consumer choice behavior and the market expansion effects, to calibrate the new model. Our empirical study on a real data set shows the efficiency of our estimation method and the importance of incorporating the market expansion effects into consumer choice models. Failure to account for the market expansion effects may lead to substantial losses in demand estimation and operations management.