An Economic Analysis of Product Differentiation under Latent Separability

This paper develops an analysis of markets for differentiated products. It relies on the concept of latent separability for consumer preferences. As proposed by Blundell and Robin, latent separability assumes that purchased products are allocated in the production of latent intermediate utility-yielding goods. Product differentiation can arise when each product makes a different contribution to the production of the latent goods. Latent separability is particularly attractive in the investigation of markets for branded products where the number of brands is large. It allows focusing on the demand for a smaller number of latent goods. Our approach is based on a quadratic almost ideal demand system (Q-AIDS), which provides a flexible representation of consumer behavior. Its usefulness is illustrated in an empirical analysis of markets for carbonated soft drinks (CSD). First, the econometric analysis accounts for the endogeneity of prices for differentiated brands. Second, it provides an empirical evaluation of the number of relevant latent goods. Third, it shows how latent separability improves the efficiency of parameter estimates. Finally, it generates estimates of shadow prices of the latent goods, information that gives useful insights into the economics of differentiated products.