Bhuyan, Sanjib, and Lopez Oligopoly power in the food and tobacco industries

Method:

Theoretical Model

Specify a general profit function Derive several parameters related to MARKET POWER

Empirical Model

Specify a specific profit function, demand function

Collect data

Estimation of parameters - statistical methods

Method: Theoretical Model -Profit function

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Πj = (P(Y )⋅Y j −C j(W ,Y j )

P(Y ) = price (output demand function)

W = vector of input prices

Y j = firm j's output

C j = cos t of producing Y j at prices W

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∂Πj

∂Y j = sYj =

PY j

C j ≡ Revenue to cos t ratio

sYj =

∂ lnC j

∂ lnY j = 1 −θ j

η

⎛

⎝ ⎜

⎞

⎠ ⎟

Differentiate profit with respect to output

Method: Theoretical Model: Parameters

( )jj

j

MCtolinkedtofelasticityoutputY

Cε

∂

∂/1) ( cos

ln

ln==

Output elasticity of cost - reciprocal of “economies of size”

eg. for a 1% increase in output, is there more or less percent change in cost?

) (

elasticity lconjectura = ln

ln

jfirmofoutputtheinchangeatoresponseinYoutputindustryinchangeY

Yj

j

∂∂θ =

?

ln

)(ln

levelpricetheinchangeatoreactoutputindustrydoesHow

industrythefordemandoutputofelasticityP

YP

∂∂η −=

Method: Theoretical Model: Lerner Index (L)

Measures degree of the exercise of oligopoly power

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L =P −MC

P=φ

η

MC = MC for the industry

φ = industry level conjectural var iations elasticity

η = elasticity of output demand

Method: Empirical Model

Specify a Translog Cost function (Transcendental-logarithmic)

Ln(C) = f(W,Y,T)C = industry total costY = industry outputT = time trendW = vector of input prices (wi)

Logarithmic differentiation (Shephard’s Lemma) factor (input) share equations

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∂ lnC

∂ lnwi

= wi⋅ x iC

= Si (input share equations) = f (wi,Y,T)

Method: Empirical Model

Specify a Cobb-Douglas output demand function (derived demand facing industry)

€

lnY = D(lnP, lnq, lnZ, lnT)

P = price of output

Z = substitute price

q = income

T = time trend

Method: Estimation

Statistical methods - estimate the parameters of a system of equations

L - Lerner index - elasticity of returns to scale - conjectural variation elasticity for the industry

( = 0 => no strategic activity e.g. price taking)η - output demand elasticity

4 input share equations (KLEM) (derived from C=C (W,Y,T)1 demand function (Cobb-Douglas)1 equation representing profit max criterion

Annual data 1972 – 1987

40 food and tobacco processing industries: SIC 4 digit level

Results:

1) Testing the Lerner index

H0: L = 0

Reject => evidence of oligopoly power (price distortion)

Rejected - 37 of 40 industries (average L = 0.33)

"degree of oligopoly power is significant"

Results:2) Other Parameters

- conjectural variation elasticity - mostly greater than zero and significant- evidence of strategic behaviour

η - output demand elasticity – inelastic in all cases

- elasticity of scale ..... mostly increasing returns e.g. > 1

Constant returns to scale - CRS rejected for 33 industries

Ho: = 0

20 industries – increasing returns > 113 industries – decreasing returns > 1

Statistical Significance – high in most cases

Aggregate Industries SIC 2: - Food Industries- Tobacco Industries- Food & Tobacco

Comparisons with Previous Research