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How (not) to measure competition

  • Boone, Jan
  • van der Wiel, Henry
  • van Ours, Jan C

We introduce 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 policy relevance. 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 C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6275.

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Date of creation: May 2007
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Handle: RePEc:cpr:ceprdp:6275
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  8. Aviv Nevo, 2003. "Measuring Market Power in the Ready-to-Eat Cereal Industry," Microeconomics 0303006, EconWPA.
  9. Boone, J., 2004. "A New Way to Measure Competition," Discussion Paper 2004-31, Tilburg University, Center for Economic Research.
  10. Berry, Steven & Levinsohn, James & Pakes, Ariel, 1995. "Automobile Prices in Market Equilibrium," Econometrica, Econometric Society, vol. 63(4), pages 841-90, July.
  11. 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. Balk, B.M., 2001. "The Residual: On Monitoring and Benchmarking Firms, Industries, and Economies with respect to Productivity," ERIM Inaugural Address Series Research in Management EIA-2001-007-MKT, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam..
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  21. Boone, J., 2003. "Optimal competition : A benchmark for competition policy," Discussion Paper 2003-010, Tilburg University, Tilburg Law and Economic Center.
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  23. Franklin M. Fisher, 1987. "On the Misuse of the Profits-Sales Ratio to Infer Monopoly Power," RAND Journal of Economics, The RAND Corporation, vol. 18(3), pages 384-396, Autumn.
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  26. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716.
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