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Capacity and Product Market Competition: Measuring Market Power in a "Puppy-Dog" Industry

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  • Lars-Hendrik Röller
  • Robin C. Sickles

Abstract

In this paper we specify and estimate a structural model which accounts for competition in two variables: capacity and prices. The model has a two-stage setup. In the first stage firms make capacity decisions followed by a product-differentiated, price setting game in the second stage. Since costs are endogenized through the first stage, this has important implications for the measurement of market power in the product market. In particular, simpler one-stage specifications would result in a bias in the measurement of market power, which can be linked to the taxonomy for two-stage games given in Fudenberg and Tirole (1984). We then estimate this model - demand, cost (short and long run), and conduct - for the European Airline Industry using data for the period of 1976-1990. We perform a number of specification tests and reject a simple one-stage specification in favor of our two-stage set-up. In particular, we find that some degree of market power in the product market exists. However, market power in the two-stage set-up is significantly lower than in the more widely employed one-stage specification, which is consistent with the direction of bias in puppy-dog games. This illustrates that firms market power in the product market is significantly overestimated whenever capacity competition is not accounted for. ZUSAMMENFASSUNG - (Kapazitäts- und Produktmarktwettbewerb: Die Messung von Marktmacht in einer "Puppy-Dog"-Industrie) In diesem Beitrag wird ein strukturelles Modell entwickelt und ökonometrisch geschätzt, das zwei Variablen des Wettbewerbs berücksichtigt: Kapazität und Preise. Das Modell ist zweistufig. Auf der ersten Stufe entscheiden die Unternehmen über die Kapazität, gefolgt von einem Produktdifferenzierungs- und Preissetzungsspiel auf der zweiten Stufe. Die Endogenisierung der Kosten auf der ersten Stufe hat wichtige Implikationen für die Messung der Marktmacht im Produktmarkt. Dabei ist zu berücksichtigen, daß eine einfachere einstufige Spezifikation zu einem Meßfehler der Marktmacht führen würde, was im Hinblick auf die Taxonomie der zweistufigen Spiele von Fudenberg und Tirole (1984) deutlich wird. Sodann wird das Modell anhand von Daten geschätzt, die die Nachfrage, kurz- und langfristige Kosten und Marktverhalten der europäischen Luftfahrtindustrie für die Zeit von 1976 bis 1990 beschreiben. Eine Reihe von Spezifikationstests wird durchgeführt, die zur Ablehnung der einfachen einstufigen Spezifikation zugunsten der zweistufigen Spezifikation führt. Bemerkenswert ist, daß sich empirisch zeigt, daß das Spiel in Übereinstimmung mit einer "puppy-dog"-Strategie steht. Mit anderen Worten europäische Luftfahrtgesellschaften überinvestieren in Kapazitäten, um weniger aggressiv auftreten zu müssen. Darüber hinaus zeigt sich, daß ein gewisser Grad an Marktmacht im Produktmarkt existiert. Jedoch ist die Marktmacht in dem zweistufigen Spiel signifikant geringer als in der üblicherweise angewendeten einstufigen Spezifikation. Dies wiederum ist in Übereinstimmung mit dem Bias von "Puppy-dog"-Spielen und illustriert, daß die Marktmacht von Unternehmen auf Produktmärkten beträchtlich überschätzt wird, wann immer Kapazitätswettbewerb nicht berücksichtigt wird.

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Bibliographic Info

Paper provided by Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and Innovation (CIG) in its series CIG Working Papers with number FS IV 97-31.

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Length: 28 pages
Date of creation: Dec 1997
Date of revision:
Publication status: Published in the International Journal of Industrial Organization , Vol. 18(6), 2000, pp. 845-865.
Handle: RePEc:wzb:wzebiv:fsiv97-31

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Keywords: regulation and industrial policy; air transportation;

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References

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  1. Brueckner, Jan K. & Spiller, Pablo T., 1991. "Competition and mergers in airline networks," International Journal of Industrial Organization, Elsevier, vol. 9(3), pages 323-342, September.
  2. Borenstein, Severin, 1990. "Airline Mergers, Airport Dominance, and Market Power," American Economic Review, American Economic Association, vol. 80(2), pages 400-404, May.
  3. Berry, Steven T, 1990. "Airport Presence as Product Differentiation," American Economic Review, American Economic Association, vol. 80(2), pages 394-99, May.
  4. Appelbaum, Elie, 1982. "The estimation of the degree of oligopoly power," Journal of Econometrics, Elsevier, vol. 19(2-3), pages 287-299, August.
  5. Jan K. Brueckner & Nichola J. Dyer & Pablo T. Spiller, 1992. "Fare Determination in Airline Hub-and-Spoke Networks," RAND Journal of Economics, The RAND Corporation, vol. 23(3), pages 309-333, Autumn.
  6. Bresnahan, Timothy F., 1989. "Empirical studies of industries with market power," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 2, chapter 17, pages 1011-1057 Elsevier.
  7. Brander, James A. & Zhang, Anming, 1993. "Dynamic oligopoly behaviour in the airline industry," International Journal of Industrial Organization, Elsevier, vol. 11(3), pages 407-435, September.
  8. Berry, Steven & Levinsohn, James & Pakes, Ariel, 1995. "Automobile Prices in Market Equilibrium," Econometrica, Econometric Society, vol. 63(4), pages 841-90, July.
  9. Berry, Steven T, 1992. "Estimation of a Model of Entry in the Airline Industry," Econometrica, Econometric Society, vol. 60(4), pages 889-917, July.
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