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The Upward Pricing Pressure Test for Merger Analysis: An Empirical Examination

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  • Lydia Cheung

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    (Department of Economics, Faculty of Business and Law, Auckland University of Technology)

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    Abstract

    The Upward Pricing Pressure (UPP) test developed by antitrust economists Joseph Farrell and Carl Shapiro marks a new era in antitrust and provides an alternative to the traditional concentration-based tests in merger analysis. In addition to being free of market de nition, the UPP's appeal lies in its ease of use: one simple formula indicates whether a merging rm has an incentive to increase prices postmerger. This paper rst establishes the theoretical relationship between the UPP and the standard structural merger simulation, namely, that the UPP is a \singleproduct merger simulation" that ignores the re-equilibration of all other endogenous variables except that product's own price. To assess the consequence of this simpli cation, I compute \true" UPP values for a cross-section of airline markets using structurally estimated price elasticities, and confront them with the \gold standard" of a merger simulation. I examine the predictive accuracy of both the sign and magnitude of the UPP. I nd that it gives wrong sign predictions to an average 10% of the observations, and its value has an average correlation of 0:92 with the structurally simulated price changes. However, since this test is meant to bypass a complicated demand estimation, I then use the example of a simple logit demand to illustrate the consequence of using inaccurate demand-side inputs in the UPP: the test will give a wrong sign prediction over a much larger range of cost synergies. Lastly, I discuss the pass-through conditions for Farrell and Shapiro's proposition, demonstrate empirically that they are not innocuous, and show that their violation can lead to false positive results (type I errors) in the UPP.

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    Bibliographic Info

    Paper provided by Auckland University of Technology, Department of Economics in its series Working Papers with number 2013-03.

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    Length: 39 pages
    Date of creation: Feb 2013
    Date of revision:
    Handle: RePEc:aut:wpaper:201303

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    Related research

    Keywords: merger; upward pricing pressure;

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    1. Werden, Gregory J, 1996. "A Robust Test for Consumer Welfare Enhancing Mergers among Sellers of Differentiated Products," Journal of Industrial Economics, Wiley Blackwell, vol. 44(4), pages 409-13, December.
    2. Farrell, J. & Shapiro, C., 1988. "Horizontal Mergers: An Equilibrium Analysis," Papers 17, Princeton, Woodrow Wilson School - Discussion Paper.
    3. Steven Berry & Panle Jia, 2008. "Tracing the Woes: An Empirical Analysis of the Airline Industry," NBER Working Papers 14503, National Bureau of Economic Research, Inc.
    4. Bulow, Jeremy I & Geanakoplos, John D & Klemperer, Paul D, 1985. "Multimarket Oligopoly: Strategic Substitutes and Complements," Journal of Political Economy, University of Chicago Press, vol. 93(3), pages 488-511, June.
    5. Werden, G.J., 1996. "A Robust Test for Consumer Welfare Enhancing Mergers Among Sellers of Differentiated Products," Papers 96-01, U.S. Department of Justice - Antitrust Division.
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