Category: Industrial Organisation

The Use of Instruments in Demand Estimation

Posted on by Rhys Williams

See my earlier article on demand estimation for background.

There are two broad approaches to estimating aggregate-level demand: product-space approaches and characteristics-space approaches. Product-space approaches, such as Price Invariant Generalised Logarithmic models and Almost Ideal Demand Systems, treat individual products as the unit of analysis and endeavour to estimate demand functions using restrictions from economic theory. However, these approaches need to estimate N^2 elasticities (considering both own-price and cross-price elasticities), where N is the number of products, hence, even for a modest market with (e.g.) 20 products, over 400 parameters need to be estimated. This is computationally difficult, leading to the curse of dimensionality, and poses a key downside to product-space approaches, along with the detraction that such methods do not allow for the counterfactual estimation of new products being introduced. [...]

How to Estimate Demand

Posted on by Rhys Williams

I recently attended a fantastic workshop on demand estimation and have been doing a lot of reading around this topic recently, so wanted to share an outline of the IO story on demand estimation.

Estimating underlying demand functions – that illustrate what happens to quantity purchased when prices change – is useful for a variety of policy analyses, such as estimation of merger control, the introduction of tariffs, welfare effects, product entry etc. In essence, we want to calculate the elasticities which exist between varying products. However, this is not easy, both conceptually and computationally.

To begin with, there is a fundamental problem of endogeneity. [...]

Resale Price Maintenance and Fixed Book Prices

Posted on by Rhys Williams

This article is based on a paper I’ve just had published in the Journal of Competition Law and Economics, available here.

Resale Price Maintenance (RPM) is an agreement between manufacturers and retailers, whereby manufacturers only supply retailers with their output, if the retailer agrees to sell the products at a specified price. There are a number of valid reasons why manufacturers and retailers would agree to such a restriction on behaviour. One example is that manufacturers might want to encourage retailers to offer promotional services, or help showcase the product (for example, offering test drives of cars, making nice stands to draw customers’ attention to the latest book, providing walk-throughs of the technical specifications of different laptops, etc). [...]

Vertical Integration

Posted on by Rhys Williams

In this post, I want to talk a bit about vertical integration and some cool papers I’ve read on the topic.

To begin with, we can think of a vertical structure being a situation where we have upstream and downstream firms. Upstream firms tend to be manufacturers, or other firms high up in the production process, whilst downstream firms are retailers or firms lower down in the production process. An industry where manufacturers and retailers are non-integrated (separate) can lead to an incentive problem, whereby both firms want/need to make a profit but end up setting too high a price.

Let’s think about this more carefully. [...]

The forbidden regression of price on HHI

Posted on by Rhys Williams

I recently came across a neat paper by around 25 economists (former chief economists at the US’ FTC and DoJ Antitrust Division) which provided a rebuke of attempts by econometricians to study the relationship between price and the Herfindhal-Hirschman Index (a measure of concentration).

As a general rule, when two firms merge horizontally (i.e. at the same level within the same market), there are two mechanisms which would tend to push prices up and a counteracting force which would put downward pressure on prices. The first two mechanisms (which tend to increase price) are called unilateral and co-ordinated effects. Unilateral effects come from the fact that the merged entity has more market power than before, and it can use this market power (to some degree) to push up prices.* [...]

Competition in Professional Business Services markets

Posted on by Rhys Williams

In recent work for the European Commission, myself and colleagues have been evaluating competition in the professional business services markets with the aim of identifying which aspects of the sector inhibit effective competition. In this article I will explain a bit about our findings and highlight the different competition concerns and how economic theory is interwoven into this analysis.

Background

Firstly, what are professional business services (or PBS for short)? For this study they included accounting, legal, architectural and engineering services. These services are typically known as credence goods, in the sense that consumers often don’t know about expected service quality before they purchase the service and are unlikely to be able to evaluate quality after provision. [...]

The SSNIP Test

Posted on by Rhys Williams

Each product that exists can be classified into a market in which it competes with other products for the attention of consumers. For instance, apples might be considered a snack-fruit and compete with items including pears and bananas. In other words, if the price of apples increased then demand would substitute towards one of these other products. The market for apples, would thus include these other fruits which substitution can easily happen.

Such substitution means that apple producers are restricted in their ability to increase prices. Increasing prices too much would result in this demand substitution towards other products.

On the other hand, other products might have a more restricted market. [...]

Price Discrimination and Social Welfare

Posted on by Rhys Williams

Standard texts of price discrimination see it as beneficial in a social welfare sense: consumer surplus is transferred to producer surplus, but the fact that quantity increases is good for social welfare (as it reduces the deadweight loss triangle). Interestingly, this isn’t the whole story. Tullock pointed out, a number of years ago, that social welfare loss can originate from the rent-seeking activities of those that are trying to capture these rents.

For instance, in a monopoly setting, standard economic theory would say that the cost of monopolies comes from the reduction in quantity sold (as a result of higher prices), leading to a loss of social welfare. [...]

Brief: Cannibalisation

Posted on by Rhys Williams

Cannibalisation occurs when a company reduces the sales of one of its products by introducing a similar, competing product in the same market.

Igami and Yang study this phenomenon in relation to burger outlets, pointing out that entry of new outlets harms the profitability of existing stores (cannibalisation) but that this occurs so as to preempt the threat of rivals’ entry: i.e. a firm may have an incentive to cannibalise its market share if it thinks this will keep rivals out (by saturating the market and depriving it of store locations).

One of their main findings is that “shops of the same chains compete more intensely with each other than with shops of different chains, which implies cannibalization is one of the most important considerations for the firms’ entry decisions”. [...]

Strategic Pricing

Posted on by Rhys Williams

This article will explore an overview of pricing strategy. We begin by explaining the simple Cournot and Bertrand games, which are game theoretic analyses of a firm’s pricing strategy. With this information we proceed by explaining what strategic complementarities and substitutes are before looking at a paper by Fudenberg and Tirole entitled “The Fat-Cat Effect, the Puppy-Dog Ploy, and the Lean and Hungry Look”.

Cournot Game
In this scenario we have (at least) two firms who compete on the amount of output they produce, choosing the quantity simultaneously and independently whilst taking the output decision of the other firms as given. [...]