A price index with variable mark-ups and changing variety

Working Paper N° 356

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Abstract

This paper proposes an estimation of an augmented Tornqvist price-index - fea-
turing demand shifters - which is exact for homothetic translog preferences. Contrary
to previous work based on a constant elasticity of substitution across varieties, this
demand system allows for changes in markups even when the number of products is
large. We then propose a structural decomposition of this index in terms of changes
in markups, productivity, variety and demand shocks. We illustrate our approach
using sample data from ACNielsens Homescan Panel. For instance, our results are
consistent with competition effects where a decrease in per-product demand trans-
lates into lower markups.