(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 167

142 PART 2 • Producers, Consumers, and Competitive Markets
The specification and estimation of demand curves has been a rapidly growing endeavor, not only in marketing, but also in antitrust analyses. It is now
commonplace to use estimated demand relationships to evaluate the likely
effects of mergers.12 What were once prohibitively costly analyses involving
mainframe computers can now be carried out in a few seconds on a personal
computer. Accordingly, governmental competition authorities and economic
and marketing experts in the private sector make frequent use of supermarket
scanner data as inputs for estimating demand relationships. Once the price
elasticity of demand for a particular product is known, a firm can decide
whether it is profitable to raise or lower price. Other things being equal, the
lower in magnitude the elasticity, the more likely the profitability of a price
increase.

EXAMPLE 4 .8

THE DEMAND FOR READY-TO-EAT CEREAL

The Post Cereals division of
Kraft General Foods acquired
the Shredded Wheat cereals of
Nabisco in 1995. The acquisition
raised the legal and economic
question of whether Post would
raise the price of its best-selling
brand, Grape Nuts, or the price of
Nabisco’s most successful brand,
Shredded Wheat Spoon Size.13
One important issue in a lawsuit
brought by the state of New York was whether the
two brands were close substitutes for one another. If
so, it would be more profitable for Post to increase

the price of Grape Nuts (or Shredded Wheat) after
rather than before the acquisition. Why? Because
after the acquisition the lost sales from consumers
who switched away from Grape Nuts (or Shredded
Wheat) would be recovered to the extent that they
switched to the substitute product.
The extent to which a price increase will cause
consumers to switch is given (in part) by the price
elasticity of demand for Grape Nuts. Other things
being equal, the higher the demand elasticity, the greater the loss of sales associated with a
price increase. The more likely, too, that the price
increase will be unprofitable.
The substitutability of Grape Nuts and Shredded
Wheat can be measured by the cross-price

elasticity of demand for Grape
Nuts with respect to the price of
Shredded Wheat. The relevant
elasticities were calculated using
weekly data obtained from supermarket scanning of household
purchases for 10 cities over a
three-year period. One of the estimated isoelastic demand equations appeared in the following
log-linear form:
log(QGN) = 1.998 - 2.085 log(PGN) + 0.62 log(I)
+ 0.14 log(PSW)
where QGN is the amount (in pounds) of Grape
Nuts sold weekly, PGN the price per pound of Grape
Nuts, I real personal income, and PSW the price per
pound of Shredded Wheat Spoon Size.
The demand for Grape Nuts is elastic (at current prices), with a price elasticity of about -2.

The income elasticity is 0.62: In other words, increases
in income lead to increases in cereal purchases, but
at less than a 1-for-1 rate. Finally, the cross-price elasticity is 0.14. This figure is consistent with the fact that
although the two cereals are substitutes (the quantity
demanded of Grape Nuts increases in response to
an increase in the price of Shredded Wheat), they are
not very close substitutes.

12

See Jonathan B. Baker and Daniel L. Rubinfeld, “Empirical Methods in Antitrust Litigation: Review
and Critique,” American Law and Economics Review, 1(1999): 386–435.
13

State of New York v. Kraft General Foods, Inc., 926 F. Supp. 321, 356 (S.D.N.Y. 1995).