The Inverse Product Differentiation Logit Model

Abstract

We introduce the inverse product differentiation logit (IPDL) model, a micro-founded inverse market share model for differentiated products that captures market segmentation according to one or more characteristics. The IPDL model generalizes the nested logit model to allow richer substitution patterns, including complementarity in demand, and can be estimated by linear instrumental variables regression using market-level data. Furthermore, we provide Monte Carlo experiments that compare the IPDL model to the workhorse empirical models of the literature. Lastly, we show the empirical performance of the IPDL model using a well-known dataset on the ready-to-eat cereals market.

Keywords: Demand estimation; Demand invertibility; Differentiated products; Discrete choice; Nested logit; Random utility; Representative consumer

JEL Classification: C26, D11, D12, L