Multi-Product Competition, Shopping Costs, and Market Power: A Model of Supermarket Pricing∗

A supermarket brings together product cateogories (e.g. bread, meat) that traditionally are sold separately in specialist stores on a street (e.g. baker, butcher). This paper measures the pricing incentives of large supermarkets by considering the role of multistore shopping, shopping costs, and pricing cross-effects between product categories. We estimate a discrete/continuous model in which consumers have demands for multiple categories and can buy from more than one store (incurring shopping costs). This type of model has been used widely in the theoretical literature but rarely in empirical analysis. We compute cross-elasticities between the categories within a store and compare the pricing incentives of a category manager (who maximizes category profit) with those of the supermarket owner (who maximizes store profit). We find that the latter implies a very substantial increase in the intensity of price competition compared to the former. To investigate the sources of this effect we compare pricing incentives for different types of consumers: two-stop shoppers and one-stop shoppers. We find that supermarkets have much stronger incentives to cut prices for one-store shoppers, which suggests that consumers with relatively high shopping costs constrain the market power of supermarkets more than those with low shopping costs.