MARKET STRUCTURE AND MARKET POWER Measuring market power One firm: - - PowerPoint PPT Presentation

MARKET STRUCTURE AND MARKET POWER

Measuring market power

• One firm: margin

m = p − MC p

• Many firms: average margin, a.k.a. Lerner index

L ≡

n

• i=1

si p − MC i p

Measuring market structure

• n (number of firms), or 1/n
• Ci index

C4 ≡

4

• i=1

si

• Herfindahl-Hirsh index (a.k.a. HHI)

H ≡

n

• i=1

s2

i

• C4 ∈ [0, 100] (or [0,1]), H ∈ [0, 10, 000] (or [0,1])

What do the extremes mean?

• Pros and cons of each measure

Intensity of competition and market structure

• Exhibit 1: pharmaceutical industry in Sweden

− Each month, government auctions right to be main or sole supplier − Bertrand competition − Very high concentration: leading supplier takes from 50 to 70% market

• Exhibit 2: banking industry in Kenya

− Interest rates around 12%, no variation with respect to # competitors − Very little price price competition − High entry rates; currently more than 40 banks

• Summary: higher degree of competition, more

concentrated market

Intensity of competition and market structure

• Suppose different countries only differ on market equilibrium price

(e.g., regulation)

• Cost function C = F + c q, entry cost E
• Free entry equilibrium

1 n (p − c) D(p) − F = E

• Solving for equilibrium

n

• n =
• 1

E + F (p − c) D(p)

• Hence, lower p (more intense competition) implies lower n

(more concentrated market)

Market concentration and market power

• In previous exercise, vary intensity of competition and find free

entry equilibrium

• Alternatively, fix degree of competition (specifically, Cournot) and

vary market structure

• It can be shown that

L = H −ǫ where ǫ is price elasticity of market demand

Example

• Consider two markets with identical demands

− Market 1: two firms with identical market shares − Market 2: one firm with a 70% market share, two small firms with 15% each

• Assuming Cournot competition in both markets, where is market

power the greatest?

• Answer: whichever market has higher HHI

− Market 1: H = 502 + 502 = 5, 000 − Market 2: H = 702 + 152 + 152 = 5, 350

Structure-Conduct-Performance paradigm

• Structure determines conduct

− e.g.: collusion easier with fewer firms

• Conduct determines performance

− e.g.: Bertrand implies lower margins than Cournot

• Structure determines performance

− e.g.: fixing Cournot, L is proportional to H

Structure-Conduct-Performance hypothesis

• Positive correlation between structure (e.g., H) and performance

(e.g., L), where L is proxied by average profit rate ri ≡ Ri − VC i Ri = p qi − ci qi p qi = p − ci p = mi

• Weak relation in empirical studies

− poor data − cross industry comparisons: apples and oranges − reverse causality implies opposite correlation

Collusion v efficiency hypotheses

• Suppose that feedback effects are unimportant: structure

determines performance

• Suppose higher concentration is correlated with higher profits

(some evidence). What is source of correlation?

• Collusion hypothesis: variation in degree of collusion
• Efficiency hypothesis: variation in firm efficiency
• Either hypothesis is consistent with aggregate correlation,

but narratives and policy implications are very different