Is Average Variable Cost a Good Proxy for Short-Run Marginal Cost and Why is it Important?
AbstractAverage 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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Bibliographic InfoPaper provided by Macquarie University, Department of Economics in its series Research Papers with number 0208.
Length: 25 pages.
Date of creation: Sep 2002
Date of revision:
marginal cost; average variable cost; manufacturing; supply relation;
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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