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How (not) to measure competition

  • Jan Boone

    ()

  • Henry van der Wiel

    ()

  • J. van Ours

We discuss and apply a new measure of competition: the elasticity of a firm's profits with respect to its cost level. A higher value of this profit elasticity (PE) signals more intense competition. Using firm level data we compare PE with the most popular competition measures such as the price cost margin (PCM). We show that PE and PCM are highly correlated on average. However, PCM tends to misrepresent the development of competition over time in markets with few firms and high concentration, i.e. in markets with high relevance for competition policy and regulation. So, just when it is needed the most PCM fails whereas PE does not. From this, we conclude that PE is a more reliable measure of competition.

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Paper provided by CPB Netherlands Bureau for Economic Policy Analysis in its series CPB Discussion Paper with number 91.

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Date of creation: Dec 2007
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Handle: RePEc:cpb:discus:91
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  1. Boone, J., 2004. "A New Way to Measure Competition," Discussion Paper 2004-004, Tilburg University, Tilburg Law and Economic Center.
  2. Howitt, Peter & Griffith, Rachel & Aghion, Philippe & Blundell, Richard & Bloom, Nick, 2005. "Competition and Innovation: An Inverted-U Relationship," Scholarly Articles 4481507, Harvard University Department of Economics.
  3. Harold Creusen & Bert Minne & Henry van der Wiel, 2006. "Competition in the Netherlands; an analysis of the period 1993-2001," CPB Document 136, CPB Netherlands Bureau for Economic Policy Analysis.
  4. Vives, Xavier, 2006. "Innovation and competitive pressure," IESE Research Papers D/634, IESE Business School.
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  8. Blanchard, Olivier J & Giavazzi, Francesco, 2001. "Macroeconomic Effects of Regulation and Deregulation in Goods and Labour Markets," CEPR Discussion Papers 2713, C.E.P.R. Discussion Papers.
  9. Nevo, Aviv, 1998. "Measuring Market Power in the Ready-To-Eat Cereal Industry," Research Reports 25164, University of Connecticut, Food Marketing Policy Center.
  10. Bresnahan, Timothy F & Reiss, Peter C, 1991. "Entry and Competition in Concentrated Markets," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 977-1009, October.
  11. Nickell, S.J., 1993. "Competition and Crporate Performance," Economics Series Working Papers 99155, University of Oxford, Department of Economics.
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  13. Klette, T.J., 1998. "Market Power, Scale Economies and Productivity: Estimates from a Panel of Establishment Data," Memorandum 15/1998, Oslo University, Department of Economics.
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  16. Roeger, Werner, 1995. "Can Imperfect Competition Explain the Difference between Primal and Dual Productivity Measures? Estimates for U.S. Manufacturing," Journal of Political Economy, University of Chicago Press, vol. 103(2), pages 316-30, April.
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  19. repec:dgr:kubtil:2003010 is not listed on IDEAS
  20. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, June.
  21. Boone, Jan, 2003. "Optimal Competition: A Benchmark for Competition Policy," CEPR Discussion Papers 3766, C.E.P.R. Discussion Papers.
  22. Bresnahan, Timothy F & Reiss, Peter C, 1990. "Entry in Monopoly Markets," Review of Economic Studies, Wiley Blackwell, vol. 57(4), pages 531-53, October.
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  24. N. Gregory Mankiw & Michael D. Whinston, 1986. "Free Entry and Social Inefficiency," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 48-58, Spring.
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