Systematic relationship between concentration and price

Price-Concentration Studies: There You Go Again | ATR | Department of Justice

systematic relationship between concentration and price

Numerous studies have shown that there is usually a systematic relationship between concentration and price. What is this relationship?. Asset Pricing Model (CAPM) to derive the relationship between product market correlation between β and firms' market share and concentration is consistent. high seller concentration than with moderate or low seller concentra- tion if we posit a systematic association between the probability of price is enough lower to .

Monopolistic competition best describes the nature of competition in the restaurant industry. It has numerous sellers which do not react to fluctuations in a single competitor. The products in serving restaurant are vertically differentiated such as Italian, Japanese, Mexican cuisines. Customers have high power to select their food depending on the consumers' preferences as well as price.

KFC participates in horizontal differentiation when it compares with Church's fried chicken.

Price-Concentration Studies: There You Go Again

Submarkets concern geography as well, with location a distinct competitive factor in horizontal differentiation. In highly competitive conditions, restaurants may decide to provide alternative advertising media - such as direct mail, TV commercials, online advertising, and coupons, in order to approach prospective and current customers. The many forms of advertising can reduce consumer search costs. They persuade consumers to choose one product over others, and these restaurants are able to increase their market shares.

If the products are in horizontal differentiation, low search costs may cause lower prices and lower profit for all firms. How does industry-level price elasticity of demand shape the opportunities for making profit in an industry? How does the firm-level price elasticity of demand shape the opportunities for making profit in an industry?

An industry's price elasticity of demand is less elastic than for any firm in that industry. Therefore, provided that a good or service in an industry maintains its perceived value or utility, firms may raise prices and expect total revenue to rise. However, if the good is seen as a luxury, higher prices will cause total revenues to fall. However, at the firm level, elasticity is higher, because competitors' goods are seen as close substitutes.

Individual firms must be creative - perhaps even "reinvent" the product, market it as superior to all the others to lower elasticity, or optimize their resources to help drive costs down to increase margin.

The firm level elasticity forces companies to minimize the perception of close substitutes or be a low-cost leader in order to survive in a competitive environment. Numerous studies have shown that there is usually a systematic relationship between concentration and price. What is this relationship? Offer two brief explanations for this relationship. In an underappreciated paper, Png and Reitman examine competition among gasoline stations. The gasoline stations of different firms seem similar and the main product they sell--gasoline--seems very homogeneous.

Some stations offer persistently lower prices but have smaller capacities and at them, customers wait longer; higher-priced stations offer shorter waiting times. With many gasoline quality parameters regulated, the obvious question is if there is a difference among gasoline brands. The answer is a resounding yes. Differentiation is achieved through proprietary additive packages which contain anti-oxidants, metal deactivators, surfactants, deposit modifiers, corrosion inhibitors, and, of course, octane enhancers.

In addition, gasoline retailers vary significantly in the level of care taken to prevent contamination; some companies have specific quality control procedures and special equipment to avoid contamination while others do not. Non-price competition is not restricted to just these four industries. It is important in virtually all consumer-good industries and perhaps surprisingly, even in most producer-good industries.

One simply has to look at how initially higher-priced audio CDs replaced vinyl records and at the success of Starbucks to see the importance of non-price competition. But we also have the statements of experts. Mueller observedp. The typical firm earning persistently high profits has a large market share in a differentiated product industry.

If it is more efficient than its competitors, it is not because it produces the same product as they at lower costs, and sells it at lower prices. If anything, the price it charges probably exceeds that of its competitors for a product that is perceived to be superior along one or more product characteristic dimensions.

Firms with high market shares tend to be more efficient than their competitors at developing their products, marketing them, and, perhaps most important of all, maintaining their image as a superior product. The successful firm is more efficient than its competitors in using nonprice modes of competition. To a greater or lesser degree, virtually all markets involve some element of product differentiation.

Even in a classic homogeneous goods market--such as the market for an agricultural commodity or for a specific chemical compound--producers often attempt to differentiate themselves based on product quality, reliability, or customer service.

I was struck by how different prices were for what you would think about as pure homogeneous commodity goods. And what that tells you is it's very hard to describe the product. You can describe the physical characteristics, but there are other characteristics like the speed of delivery, the timeliness of delivery, the reliability of delivery.

All of these are very hard to measure, and account for very wide differences in prices. Roberts and Supinap. While no manufactured product is perfectly homogeneous across sellers, we have chosen products to come as close as possible to that norm.

Even in these cases, there exists substantial and persistent variation in output prices and markups across plants for most of the products we study. Other observers make similar statements.

The Concepts of Own and Cross-Price Elasticities - Research Paper

Non-price competition has been growing in breadth and intensity and will likely to continue to do so. Can't adding quality or cost variables to the estimated regression model control for elements of non-price competition? In a word, no.

Here are three reasons why. It is serious challenge to identify, let alone measure, all the important forms of non-price competition. Baker and Rubinfeldp. Accordingly, testimony and documentary evidence can be marshaled to improve the measurement of marginal cost or confirm that existing measurements are reasonable.

But let's consider how difficult the problem likely is, both generally and with two specific examples. Leary outlines no fewer than six types of product differentiation that maybe important: Betancourt and Gautschiargue that to fully account for retail services, one must consider five types of retail services: Consider two specific examples of the difficulty.

Grocery retailers are now competing vigorously to save shoppers' time. In a price-concentration study of grocery retailing one could imagine proxying this form of competition by the number of checkout stands and the number of time-saving services, such as prepared foods, offered.

But Coggins and Senauerpp note that it wouldn't be as simple as that: In a traditional store it is inconvenient to shop for just a few items or just part of the store. The traditional layout frustrates some customers, however, who find it much easier to shop at convenience stores for such items.

Some supermarkets have responded by dramatically redesigning their stores so that the very process of shopping is altered. If it could be quantified, what would it cost to measure? Coggins and Senauer also note, p. Second, economic theory does not demand that business executives be able to measure--or even specify--their marginal costs to the satisfaction of economists.

At the leading firm in the office supply superstore market, executives apparently didn't fully understand their marginal cost until recently Schlosser, Within a year of installing Hyperion's Essbase, the finance department realized Staples had been misusing the display space in its stores.

The shops had long devoted part of their floor space to desks, file cabinets, and other furniture. It had seemed to make sense: The big products delivered better gross margins than pens and paper. But the BI [business information] system revealed that the strategy was a mistake. For the sake of argument, let's suppose a diligent investigator is able to identify and measure all the significant non-price factors.

But an even bigger problem is created if the analyst includes proxies for cost or quality that the sellers control; the estimated model would no longer be a valid reduced form. For example, consider store size.

Some price-concentration studies in grocery retailing include store size as an independent variable. The rationale is that bigger stores can exploit economies of scale and can thus operate at lower average cost.

The predicted impact on price is therefore negative. What if firms in more concentrated markets operate larger stores? In a labor-market context, Mark Killingsworth labelsp. If the object is to estimate the total effect of X on Z, then controlling for Y is usually not advised. Quality and cost differences that the firms can affect should not be controlled for by adding variables to a price-concentration model.

They shouldn't be added--at least in a single-equation model estimated by OLS, which is what most price-concentration studies have employed. Doing so obscures the net effect of seller concentration and that is what the investigator is interested in measuring.

What, then, of including exogenous proxies for cost and quality differences? A variable such as metropolitan-area income? I can't be too critical of this because I've done it myself. Small, statistically insignificant coefficients for seller concentration with such exogenous cost or quality proxies in the equation should be sufficient--though not necessary--to question the presence of market power through coordinated effects.

And Leonard Weiss proposed a, p. Our typical study will involve some sort of regression that explains price in terms of costs as well as concentration. Aren't we introducing price-cost margins through the back door? For the most part no. Usually we are not introducing unit costs in an industry but a variable that affects it.

We don't use unit labor costs in cement in determining the costs of a region's cement plants but average hourly earnings in all manufacturing in that region.

We feel that in the typical study we have to use cost, but costs in these forms are so far removed from those actually incurred by the firms involved that they are consistent with a huge range of profits. Completely reversing the usual argument, though, Weiss is advising us to find proxies that are weak.

Weak proxies, proxies "far removed" from the firms' actual costs, permit the investigator to interpret the estimated regression as a reduced form and allow the investigator to straightforwardly assess the impact of seller concentration on price. But weak proxies will also leave most of the cost and quality differences unexplained. I imagine that you won't be able to explain the price Starbucks charges for its coffee through metropolitan wage rates. If, on the other hand, the weak proxies are actually strong and highly correlated with firm costs, we have the problem to which Weiss alludes: But they are unlikely to solve, in either a general or powerful way, the problem that non-price competition poses for price-concentration studies.

I close this section by discussing another problem that, while not as serious as the interpretational difficulty, should also remind us of the profit-concentration literature: In grocery retailing, for example, measuring transaction prices is not necessarily simple. The analyst must contend with coupons, sales, and consumer loyalty programs Scheffman and Coleman,p.

Scanner data provided by Nielsen or IRI, which investigators without subpoena power rely on, has some notable weaknesses: In producer-goods markets, actual transactions price maybe even harder to observe. Businesses go to great lengths to keep their deals secret. It is a common term of sale contracts--put in at the insistence of the seller--that the buyer may not disclose the terms.

And when the buyer is a large organization, deals are often structured so that only the top management of the buying company knows the actual terms. It is a common practice to issue invoices at prices above actual prices. The difference is made up in a secret rebate handled only by top management. Price-concentration studies of industries without non-price competition have a different, but also serious, problem Suppose a price-concentration study is done on an industry that, despite the discussion above, we believe competes only on price.

Say cement, as Weiss, and Scherer and Ross suggested p. Or say office supply superstores. There are still two, closely related problems. Why does seller concentration differ across the local markets? By assumption, the product and its quality and conditions of sale are the same. Within a given industry the production technology surely must not vary much.

And what if prices differ because costs differ? Many observers have noted that a positive price-concentration relationship might not be due to market power but might simply be due to higher costs in more concentrated markets. Several studies of the cement industry report a positive correlation between prices and seller concentration.

But these studies did not fully account for two significant characteristics of the cement industry. One, cement production has significant economies of scale. And two, cement has a low value relative to its weight, so it is expensive to transport.

Together, these characteristics imply that it will be more costly to serve relatively small, isolated markets. When I added proxies for these factors, population density and population, to a price-concentration model for cement, the impact of concentration became much weaker and statistically in significant Newmark, But what if all markets are large enough to support at least one optimally sized plant and, if there are multiplant economies of scale, at least one firm fully exhausting those economies?

As Lambson and Demsetz explain, small market size could still be directly responsible for both higher concentration and higher costs. Lambson labels the cause 'lumpy technology" and Demsetz labels it "indivisibility" but the underlying concept is the same. Here's what the concept means. Consider a set of competing firms, N, each producing a single output, q, and each having identical U-shaped average cost curves.

Some demand is not satisfied, so market price rises. Each of the N firms expands output along its rising marginal cost curve.

  • Market concentration
  • The Concepts of Own and Cross-Price Elasticities

Each firm makes economic profit: Then, in the standard model of perfect competition, at least one new entrant is attracted into the industry. All firms, including the entrant, would suffer negative economic profits. The result is that the potential entrant does not enter. The market is in equilibrium at a price that permits incumbent firms to earn economic profits, a price that exceeds average cost.

These, then, are the pieces of the theory: The correlation is not a coordinated effect and it is not a unilateral effect. Significantly, the theory implies that the higher prices of small, concentrated markets do not demonstrate that increases in concentration in larger markets will raise price. There must be a factor, or factors, fostering economics of scale such that the average cost minimizing output was "relatively" large. There must be a wide range of market sizes, with some markets being "relatively" small.

And there must be higher concentration in smaller markets. These conditions seem to have been met. At the store level, an important advantage of superstores over traditional office supply stores is that superstores stock, at a minimum, a large number of items, some 5, or 6, At the firm level, Demsetz argued that an important source of indivisibility is advertising and there is evidence that OSS firm realize advertising economies of scale.

Salkir and Warren-Boulton statedpp. Let's look at four pieces of information connected with Staples against the background provided by this theory. The FTC employed a compelling example of its case. One Office Depot memo stated Singer,"We have one pricing zone in our company that is made up of stores that do not have any superstore competition.

This zone contains the highest-priced stores in our company, as these stores do not have any competition. But a business executive's use of "noncompetitive" does not have to match an economist's use of the word. If "noncompetitive" markets tended to be the smallest markets, the indivisibility theory predicts higher prices in them, higher prices having no connotation of lack of competition in the economic sense.

The defendants argued that, in fact, costs were higher in one-firm OSS markets. They cited a "myriad of other factors" including variations in sales volume, product mix, real estate and advertising costs, wages, a store's distance from regional distribution centers, demographics, and the higher costs of doing business in rural areas.

They also couldn't quantify these higher costs to the trial judge's satisfaction. The FTC also looked very carefully for cost differences--FTC economists considered costs beyond those the defense formally presented at trial--but didn't find any costs that could explain the higher prices. Baker wrotep. What costs, specifically, were higher? Why couldn't the FTC find any? I don't claim to offer a complete answer to these questions. But I can make one general comment about measuring costs and three comments based on the indivisibility theory.

Determining marginal marketing, warehousing, information-systems, and transportation costs for office supply superstores should be similarly challenging.

Even a cost apparently easy to measure--labor expense--can involve difficulties. For example, Dunne and Roberts used data at the plant level to estimate a reduced-form equation for the price of bread.

systematic relationship between concentration and price

They found that production workers' wages were not significant, while non-production workers' wages were significant but negatively related to price. They decided that the most likely explanation for the second result was that wage rates for non-production workers reflected differences in worker qualitypp.

Only if investigators compute marginal cost would cost fully "explain" higher prices, but as just noted marginal cost can be difficult to measure. Suppose an average cost minimizing store can servepeople. If the market haspeople, two stores perfectly fit. If the two stores belong to different firms who compete vigorously, price will approach minimum average cost. But if the market haspeople orpeople, two stores will not fit perfectly and holding the degree of competitiveness constant, price should be higher than in the ,person city.

This nonlinearity complicates measuring the effect of indivisibility. More expensive because if executives act as if they know above-normal profits can be earned from lack of fit, there should be intense, costly competition to be first to enter smaller markets Demsetz,p. That there is possibly more risk is suggested by two things. Part of the conventional wisdom about Wal-Mart's success is that they exploited a crucial error made by Sears and the other general merchandise chains.

Those chains could have entered the small, mostly Southern towns where Wal-Mart got its start.

systematic relationship between concentration and price

But, the story goes, Sears and the other chains thought that rural towns might not support large chain stores, hence entering them would be too risky. Another possible source of risk for a firm entering a small market is the possibility that one of its competitors might overestimate the market's potential.

Over-entry into a small market could drive price further below the breakeven level then over-entry into a large market. Measuring either of these costs would be challenging, to say the least. But the hypothesis of greater risk in smaller markets might be testable by looking at the geographic pattern of store closings and firm exits.

A necessary condition for the theory to apply to Staples is that the one-firm OSS markets were smaller than two- and three-firm markets. An expert witness testified that one-firm markets were "typically" smaller. I computed the median population of the two-firm markets asand the median population of the three-firm markets as 1, Petersburg, and Washington, D.

Staples-only areas had a median population even smaller, ,