Estimation of the demand function and calculation of optimal prices taking externalities into consideration

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The purpose of this study is to investigate the effects of consumption externalities with macro reference groups on firms' optimal prices and profits. Our analysis consists of the following three steps: First, using a conjoint analysis data, we construct a hierarchical Bayesian model and derive an individual utility function. Second, we estimate the demand functions when the externalities are present or not. Last, we calculate the profit functions and derive the optimal prices with and without externalities. Applying our method to the book market of Japan, it is found that the optimal price is lower when externality is present than when absent. This is why pricing low and selling a large number of books from an early stage increase the externality effect, yielding the higher profit.

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