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The Welfare Effects of Price Advertising with Basket Shopping : Structural Estimates from Supermarket Promotions

This essay empirically examines the welfare effects of informative price advertising (promotions) in the supermarket retail industry, using structural estimation and individual scanner data. The welfare implications of promotions are determined by three effects: the demand-creating effect, the business stealing effect, and the transportation erosion effect. Transportation erosion is often ignored in the literature, but is found to be important in this empirical study. Using a spatial model accounting for consumer shopping behavior and retailer pricing behavior, structural estimates of consumer demand and the marginal costs of promotion are respectively obtained following the discrete choice literature and the moment inequality approach. The structural estimates from this model allow me to numerically examine all components of market surplus and predict counterfactual outcomes. The results show a considerable erosion of consumer surplus due to transportation, and that private promotion intensities are socially excessive in the current equilibrium, but socially inadequate if transportation erosion were absent. Counterfactual experiments show that in this particular market intensified competition may actually lead to lower market surplus because longer distances are traveled for better deals, outweighing the surplus gain due to quantity expansion; slightly higher promotion costs, which may be due to an advertising tax, improve market efficiency since retailers offer less promotions and consumers shop at closer stores. In the other counterfactual experiment with zero transportation costs (roughly resembles on-line shopping), I found that the market surplus is significantly improved (115%) with this modern shopping channel.