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Capacity and product market competition: measuring market power in a 'puppy-dog' industry

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  • Roller, Lars-Hendrik
  • Sickles, Robin C.

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 Spezif
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  • Roller, Lars-Hendrik & Sickles, Robin C., 2000. "Capacity and product market competition: measuring market power in a 'puppy-dog' industry," International Journal of Industrial Organization, Elsevier, vol. 18(6), pages 845-865, August.
  • Handle: RePEc:eee:indorg:v:18:y:2000:i:6:p:845-865
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    5. Gagnepain, Philippe & Marin, Pedro L, 2006. "Regulation and Incentives in European Aviation," Journal of Law and Economics, University of Chicago Press, vol. 49(1), pages 229-248, April.
    6. Damien J. Neven & Lars-Hendrik Röller & Zhentang Zhang, 1997. "Union Power and Product Market Competition: Evidence from the Airline Industry," CIG Working Papers FS IV 97-38, Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and Innovation (CIG).
    7. Dairo Estrada, 2005. "Efectos de las fusiones sobre el mercado financiero colombiano," Borradores de Economia 329, Banco de la Republica de Colombia.
    8. Ivaldi, Marc & McCullough, Gerard, 2005. "Welfare Trade-Offs in US Rail Mergers," CEPR Discussion Papers 5000, C.E.P.R. Discussion Papers.
    9. Damien J. Neven & Lars-Hendrik Röller & Zhentang Zhang, 2002. "Endogenous Costs and Price-Cost Margins," Discussion Papers of DIW Berlin 294, DIW Berlin, German Institute for Economic Research.
    10. Ma, Tay-Cheng, 2005. "Strategic Investment and Excess Capacity: A Study of the Taiwanese Flour Industry," Journal of Applied Economics, Universidad del CEMA, vol. 8(1), pages 1-18, May.
    11. Ma, Tay-Cheng, 2008. "Disadvantageous collusion and government regulation," International Journal of Industrial Organization, Elsevier, vol. 26(1), pages 168-185, January.
    12. Gagnepain, Philippe & Marín Uribe, Pedro Luis, 2005. "Alliances in the Air: Some Worldwide Evidence," CEPR Discussion Papers 5063, C.E.P.R. Discussion Papers.
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    15. Rakotoarisoa, Manitra A. & Henneberry, Shida Rastegari & Shapouri, Shahla & Trueblood, Michael A., 2003. "The Export Market For Differentiated Processed Agricultural Products: The Role Of Factor Prices And Fixed Costs," 2003 Annual meeting, July 27-30, Montreal, Canada 21964, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    16. Bhattacharyya, Aditi & Kutlu, Levent & Sickles, Robin C., 2018. "Pricing Inputs and Outputs: Market prices versus shadow prices, market power, and welfare analysis," Working Papers 18-009, Rice University, Department of Economics.
    17. Adler, Nicole & Hanany, Eran, 2016. "Regulating inter-firm agreements: The case of airline codesharing in parallel networks," Transportation Research Part B: Methodological, Elsevier, vol. 84(C), pages 31-54.
    18. Timothy Gunning & Robin Sickles, 2013. "Competition and market power in physician private practices," Empirical Economics, Springer, vol. 44(2), pages 1005-1029, April.
    19. Philippe Gagnepain & Pedro Marin, 2010. "The effects of airline alliances: What do the aggregate data say?," Post-Print hal-00622831, HAL.
    20. Donghun Kim, 2006. "Measuring Market Power in a Dynamic Oligopoly Model: The Dallas-Forth Worth Milk Market Case," Working Papers EMS_2006_06, Research Institute, International University of Japan.
    21. Cristina Barbot, 2006. "Entry and Accommodation in Airline Markets: Easyjet Caught in the Middle on the London-Grenoble Route," CEF.UP Working Papers 0602, Universidade do Porto, Faculdade de Economia do Porto.
    22. Magdalena Sliwinska, 2015. "The Structural Power of Enterprises: Beyond the Notion of Market Power," Managing Global Transitions, University of Primorska, Faculty of Management Koper, vol. 13(2 (Summer), pages 189-206.
    23. Canhoto, Ana, 2004. "Portuguese banking: A structural model of competition in the deposits market," Review of Financial Economics, Elsevier, vol. 13(1-2), pages 41-63.
    24. Kutlu, Levent & Sickles, Robin C., 2012. "Estimation of market power in the presence of firm level inefficiencies," Journal of Econometrics, Elsevier, vol. 168(1), pages 141-155.
    25. Coccorese, Paolo, 2012. "Banks as ‘fat cats’: Branching and price decisions in a two-stage model of competition," Journal of Economics and Business, Elsevier, vol. 64(5), pages 338-363.

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