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

Author

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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.

Suggested Citation

  • Lars-Hendrik Röller & Robin C. Sickles, 1997. "Capacity and Product Market Competition: Measuring Market Power in a "Puppy-Dog" Industry," CIG Working Papers FS IV 97-31, Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and Innovation (CIG).
  • Handle: RePEc:wzb:wzebiv:fsiv97-31
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    References listed on IDEAS

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    2. Tomaso Duso & Astrid Jung, 2012. "Product Market Competition and Lobbying Coordination in the U.S. Mobile Telecommunications Industry," Journal of Industry, Competition and Trade, Springer, vol. 12(2), pages 177-201, June.
    3. 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).
    4. Jozef Konings & Patrick Van Cayseele & Frédéric Warzynski, 2010. "The Implementation of National Competition Policy Law and the Dynamics of Price–Cost Margins: Evidence from Belgium and the Netherlands 1993–1999," Chapters,in: Innovation, Economic Growth and the Firm, chapter 9 Edward Elgar Publishing.
    5. Philippe Gagnepain & Pedro Marín, 2010. "The effects of airline alliances: what do the aggregate data say?," SERIEs: Journal of the Spanish Economic Association, Springer;Spanish Economic Association, vol. 1(3), pages 251-276, July.
    6. Tay-Cheng Ma, 2005. "Strategic investment and excess capacity: A study of the Taiwanese flour industry," Journal of Applied Economics, Universidad del CEMA, vol. 8, pages 153-170, May.
    7. 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.
    8. 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.
    9. 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).
    10. Timothy Gunning & Robin Sickles, 2013. "Competition and market power in physician private practices," Empirical Economics, Springer, vol. 44(2), pages 1005-1029, April.
    11. Dairo Estrada, 2005. "Efectos de las fusiones sobre el mercado financiero colombiano," Borradores de Economia 329, Banco de la Republica de Colombia.
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    13. Ivaldi, Marc & McCullough, Gerard, 2005. "Welfare Trade-Offs in US Rail Mergers," CEPR Discussion Papers 5000, C.E.P.R. Discussion Papers.
    14. 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.
    15. 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.
    16. 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.
    17. Ma, Tay-Cheng, 2008. "Disadvantageous collusion and government regulation," International Journal of Industrial Organization, Elsevier, vol. 26(1), pages 168-185, January.
    18. 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.
    19. Gagnepain, Philippe & Marín Uribe, Pedro Luis, 2005. "Alliances in the Air: Some Worldwide Evidence," CEPR Discussion Papers 5063, C.E.P.R. Discussion Papers.
    20. Li, Hongyan & Meissner, Joern, 2011. "Competition under capacitated dynamic lot-sizing with capacity acquisition," International Journal of Production Economics, Elsevier, vol. 131(2), pages 535-544, June.
    21. 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.
    22. 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.
    23. 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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