How Market Power Affects Dynamic Pricing: Evidence from Inventory Fluctuations at Car Dealerships

Abstract

This paper investigates empirically the effect of market power on dynamic pricing in the presence of inventories. Our setting is the auto retail industry; we analyze how automotive dealerships adjust prices to inventory levels under varying degrees of market power. We first establish that inventory fluctuations create scarcity rents for cars that are in short supply. We then show that dealers' ability to adjust prices in response to inventory depends on their market power, i.e., the quantity of substitute inventory in their selling area. Specifically, we show that the slope of the price-inventory relationship (higher inventory lowers prices) is significantly steeper when dealers find themselves in a situation of high rather than low market power. A dealership with high market power moving from a situation of inventory shortage to a median inventory level lowers transaction prices by about 0.57% ceteris paribus, corresponding to 32.5% of dealers' average per vehicle profit margin or 145.6 on the average car. Conversely, when competition is more intense, moving from inventory shortage to a median inventory level lowers transaction prices by about 0.3% ceteris paribus, corresponding to 90.9, or 20.2% of dealers' average per vehicle profit margin. To our knowledge, we are the first to empirically show that market power affects firms’ ability to dynamically price.