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Is Average Variable Cost a Good Proxy for Short-Run Marginal Cost and Why is it Important?

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Author Info
Michael Olive () (Department of Economics, Macquarie University)
Abstract

Average variable cost is often used as a proxy for short-run marginal cost in empirical studies of manufacturing firm behaviour. Assuming that average variable cost is equal to marginal cost, Cowling and Waterson (1976) derive a model that links industry structure to the industry price-cost margin and Areeda-Turner (1975) provide a test of predatory pricing. However, the research on the relationship between average variable cost and short-run marginal cost mainly comes from survey studies. This paper employs a supply relation similar to Bresnahan's (1982) in order to estimate industry marginal cost divided by industry average variable cost (MC/AVC) for 89 four-digit Australian manufacturing industries during 1971 to 1984. The 3SLS results indicate that MC/AVC is not significantly different from one in 40 percent of industries, but is cyclical in only 30 percent of industries. This suggests that industry average variable cost multiplied by a constant can be used as a proxy for industry marginal cost for a large number of industries over a short period.

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File URL: http://www.econ.mq.edu.au/research/2002/8-2002Olive.PDF
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File Function: First Version, 2002
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Publisher Info
Paper provided by Macquarie University, Department of Economics in its series Research Papers with number 0208.

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Length: 25 pages.
Date of creation: Sep 2002
Date of revision:
Handle: RePEc:mac:wpaper:0208

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Postal: Sydney NSW 2109
Web page: http://www.econ.mq.edu.au/
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Related research
Keywords: marginal cost; average variable cost; manufacturing; supply relation;

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Find related papers by JEL classification:
D2 - Microeconomics - - Production and Organizations
L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
L6 - Industrial Organization - - Industry Studies: Manufacturing

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  1. Cowling, Keith & Waterson, Michael, 1976. "Price-Cost Margins and Market Structure," Economica, London School of Economics and Political Science, vol. 43(171), pages 267-74, August. [Downloadable!] (restricted)
  2. Ian Domowitz & R. Glenn Hubbard & Bruce C. Petersen, 1988. "Market Structure and Cyclical Fluctuations in U.S. Manufacturing," NBER Working Papers 2115, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Basu, Susanto & Fernald, John G, 1997. "Returns to Scale in U.S. Production: Estimates and Implications," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 249-83, April.
    Other versions:
  4. Madden, Gary G & Savage, Scott J, 2000. "Market structure, competition, and pricing in United States international telephone service markets," MPRA Paper 11161, University Library of Munich, Germany. [Downloadable!]
  5. Bloch, Harry, 1992. "Pricing in Australian Manufacturing," The Economic Record, The Economic Society of Australia, vol. 68(203), pages 365-76, December.
    Other versions:
  6. Bresnahan, Timothy F., 1982. "The oligopoly solution concept is identified," Economics Letters, Elsevier, vol. 10(1-2), pages 87-92. [Downloadable!] (restricted)
  7. Steen, Frode & Salvanes, Kjell G., 1999. "Testing for market power using a dynamic oligopoly model," International Journal of Industrial Organization, Elsevier, vol. 17(2), pages 147-177, February. [Downloadable!] (restricted)
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  8. Morrison, Catherine J, 1992. "Markups in U.S. and Japanese Manufacturing: A Short-Run Econometric Analysis," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(1), pages 51-63, January.
    Other versions:
  9. Bloch, Harry & Olive, Michael, 1999. "Cyclical and Competitive Influences on Pricing in Australian Manufacturing," The Economic Record, The Economic Society of Australia, vol. 75(230), pages 268-79, September.
  10. Gary Madden & Scott J. Savage, 2000. "Market Structure, Competition, and Pricing in United States International Telephone Service Markets," The Review of Economics and Statistics, MIT Press, vol. 82(2), pages 291-296, May. [Downloadable!] (restricted)
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    Other versions:
  12. Simon Hall & Mark Walsh & Anthony Yates, . "How do UK companies set prices?," Bank of England working papers 67, Bank of England. [Downloadable!]
  13. Weiss, C, 1993. "Price Inertia and Market Structure: Empirical Evidence from Austrian Manufacturing," Applied Economics, Taylor and Francis Journals, vol. 25(9), pages 1175-86, September.
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  16. Baumol, William J, 1996. "Predation and the Logic of the Average Variable Cost Test," Journal of Law & Economics, University of Chicago Press, vol. 39(1), pages 49-72, April.
  17. Odagiri, Hiroyuki & Yamashita, Takashi, 1987. "Price Mark-Ups, Market Structure, and Business Fluctuation in Japanese Manufacturing Industries," Journal of Industrial Economics, Blackwell Publishing, vol. 35(3), pages 317-31, March. [Downloadable!] (restricted)
  18. Catherine J. Morrison Paul, 2001. "Cost Economies And Market Power: The Case Of The U.S. Meat Packing Industry," The Review of Economics and Statistics, MIT Press, vol. 83(3), pages 531-540, August. [Downloadable!] (restricted)
  19. Blinder, Alan S, 1991. "Why Are Prices Sticky? Preliminary Results from an Interview Study," American Economic Review, American Economic Association, vol. 81(2), pages 89-96, May. [Downloadable!] (restricted)
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  20. Park, Seung-Rok & Kwon, Jene K, 1995. "Rapid Economic Growth with Increasing Returns to Scale and Little or No Productivity Growth," The Review of Economics and Statistics, MIT Press, vol. 77(2), pages 332-51, May. [Downloadable!] (restricted)
  21. Haskel, Jonathan & Martin, Christopher & Small, Ian, 1995. "Price, Marginal Cost and the Business Cycle," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 57(1), pages 25-41, February.
  22. Rosenbaum, David I. & Sukharomana, Supachat, 2001. "Oligopolistic pricing over the deterministic market demand cycle: some evidence from the US Portland cement industry," International Journal of Industrial Organization, Elsevier, vol. 19(6), pages 863-884, May. [Downloadable!] (restricted)
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