A Multi-Segment Theory of Price Elasticity Structure

Elasticity structure, the pattern of the cross-price elasticities characterizing a given market, is a revealing way of studying the nature of interbrand competition. Elasticity patterns, however, are often difficult to interpret because the underlying determinants of price elasticities are poorly understood. This paper develops a theory of elasticity structure which links a market’s preference segmentation to the patterns found in the market’s price elasticity matrix. In particular, a complex, market-level elasticity matrix may be decomposed into a small number of simple, segment-level elasticity matrices. The theory suggests ways of improving elasticity estimation and of deriving a market’s segmentation structure from cross-price elasticities. The theory also shows that, under certain conditions, the market elasticity matrix is a simple transformation of the market brand switching matrix. The authors apply the theory and test its predictive validity with survey and scanner panel data collected on consumer preference structures in the grocery coffee category.