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Oligopolistic “Agreement” and/or “Superiority”?: New Findings from New Methodologies and Data

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  • Jakubson, George
  • Jeong, Kap-Young
  • Kim, Donghun
  • Masson, Robert T.
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    Abstract

    The influential Scherer and Ross text (1990, p. 411) states that the “main question” in empirical industrial organization in the latter part of the twentieth century is Bain’s (1951) “collusion” or “agreement” hypothesis versus Demsetz’s (1973) “superior firm” hypothesis. Prior to the Federal Trade Commission Line-of-Business (LOB) studies the “contending schools were deadlocked,” but these studies led to a win being declared for the superiority hypothesis by Scherer writing with seven other LOB researchers (1987). These studies found that the effect of concentration on profits disappeared when controlling for firm shares. As many economists agreed, merger policy shifted away from a focus on agreement to applying a “unilateral effects” (non-cooperative Nash) approach. We develop a nine year panel LOB data set for Korea. We perform three types of tests, all of which support both hypotheses, but which show that the agreement effect overwhelmingly dominates the superiority effect in pricing. First we examine a secondary implication of the superiority model: profit aggregation should imply that if share is negatively related to firm profits, so should concentration be negatively related to industry profits. Instead, we find that for those industries with a negative share relationship, the concentration profits relationship is positive and virtually identical to the relationship for the full sample in both within and between panel tests. Next we introduce a commonly cited model in the empirical literature. This model is cited to motivate the proposition that both share and concentration should have an effect on firm profits. However, authors who cite this model then typically use an ad hoc specification rather than estimating this as a structural model. We develop our structural model and define latent variables to distinguish between domestic and export price cost margins (PCMs) and to identify firm “conjectures” as they impact the domestic PCM. Demand elasticities are captured in non-linear industry fixed effects. We show that concentration plays an overwhelming role in determining firm PCMs, with firm share playing a far smaller role. We additionally exploit the structural characteristics of the model to deal with the possibility that deviations between marginal costs and average costs might be driving the results. For supporting evidence we construct a new latent variable identifying the domestic/export price ratio. We find a strong “within” relationship between concentration and the domestic/export price ratio, again firm shares play a weaker role. Finally, we discuss why our results differ from the FTC-LOB studies and provide evidence that would suggest that the FTC studies’ conclusions are biased due to the 1973 removal of price controls and energy crisis, the “stagflation” of the 1970s, and the use of national firm shares along with geographically weighted averages of concentration ratios.

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    Bibliographic Info

    Paper provided by University of Connecticut, Food Marketing Policy Center in its series Research Reports with number 25181.

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    Date of creation: 2004
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    Handle: RePEc:ags:uconnr:25181

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    Keywords: Industrial Organization;

    References

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    1. Feinberg, Robert M, 1985. ""Sales-at-Risk": A Test of the Mutual Forebearance Theory of Conglomerate Behavior," The Journal of Business, University of Chicago Press, vol. 58(2), pages 225-41, April.
    2. Demsetz, Harold, 1973. "Industry Structure, Market Rivalry, and Public Policy," Journal of Law and Economics, University of Chicago Press, vol. 16(1), pages 1-9, April.
    3. Fisher, Franklin M & McGowan, John J, 1983. "On the Misuse of Accounting Rates of Return to Infer Monopoly Profits," American Economic Review, American Economic Association, vol. 73(1), pages 82-97, March.
    4. Bradburd, Ralph M & Ross, David R, 1988. "A General Measure of Multidimensional Inequality," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 50(4), pages 429-33, November.
    5. Jakubson, George, 1988. "The Sensitivity of Labor-Supply Parameter Estimates to Unobserved Individual Effects: Fixed- and Random-Effects Estimates in a Nonlinear Model Using Panel Data," Journal of Labor Economics, University of Chicago Press, vol. 6(3), pages 302-29, July.
    6. Ghosal, Vivek, 2000. "Product market competition and the industry price-cost markup fluctuations:: role of energy price and monetary changes," International Journal of Industrial Organization, Elsevier, vol. 18(3), pages 415-444, April.
    7. Hay, George A & Kelley, Daniel, 1974. "An Empirical Survey of Price Fixing Conspiracies," Journal of Law and Economics, University of Chicago Press, vol. 17(1), pages 13-38, April.
    8. Domowitz, Ian & Hubbard, R Glenn & Petersen, Bruce C, 1986. "The Intertemporal Stability of the Concentration-Margins Relationship," Journal of Industrial Economics, Wiley Blackwell, vol. 35(1), pages 13-34, September.
    9. Clarke, Roger & Davies, Stephen & Waterson, Michael, 1984. "The Profitability-Concentration Relation: Market Power or Efficiency?," Journal of Industrial Economics, Wiley Blackwell, vol. 32(4), pages 435-50, June.
    10. Geroski, P. A. & Masson, R. T. & Shaanan, S., 1987. "The dynamics of market structure," International Journal of Industrial Organization, Elsevier, vol. 5(1), pages 93-100, March.
    11. Ian Domowitz & R. Glenn Hubbard & Bruce C. Petersen, 1986. "Business Cycles and the Relationship Between Concentration and Price-Cost Margins," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 1-17, Spring.
    12. Dixit, Avinash K, 1986. "Comparative Statics for Oligopoly," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 27(1), pages 107-22, February.
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