8- Empirical IO, Identifying conduct Flashcards
What was the chain of causal links that Structure-Conduct-Performance paradigm (SCP) presumed?
Industry structure (number of firms/market share etc) affected conduct (price setting, advertising etc) which affected performance (profit, cost efficiency etc)
What was Bain’s 1951 cross industry regression?
Average industry performance regressed on market concentration and other covariates
yᵢ = α + β₁HHIᵢ + β₂Xᵢ + εᵢ
What is the Herfindhal-Hirschman Index (HHI)?
Measure of market concentration, sum of squared market shares (0 is perf comp, 1 is monopoly)
What was the main finding of Bain’s 1951 cross industry regression?
β₁ > 0 and strongly significant: more concentrated markets are more profitable on average
What was Bain’s conclusion from his 1951 regression findings?
He takes this result as evidence for abuse of market power, so suggests the radical policy of breaking up firms to curb market power and increase welfare.
What was the main flaw of Bain’s reasoning in his 1951 findings?
Arguments rely on presumed causal nature of SCP: Estimation method (OLS) assumes, rather than proves, a single causal link running from Structure to Performance
What does SCP theory suggest wrt mark-ups?
Market share is related to mark-ups, but high market share is not sufficient for high mark up: if demand is relatively elastic, then even a high market share firm cannot enjoy high mark-up.
What does SCP theory suggest wrt causality between Structure and Conduct?
No causal link running from Structure to Conduct, they are determined simultaneously in equilibrium
What are the 2 main Chicago school ideas on Industry?
-When monopoly (or market power in general) exists, it is often transitory
-Firms become big for a reason: market share differences can reflect differences in efficiency
What does empirical SCP suggest on market structure?
Cross industry regression could just reflect firm level
efficiencies: profits (mark-ups) can be high, not because of high prices, but because low costs. Therefore, breaking up firms could just lead to moving
production from efficient to less efficient firms
What is the market power hypothesis?
All firms have high mark-ups
What is the efficiency hypothesis?
High mark-ups only for large (efficient) firms
What are the 3 main reasons there is no single causal link between Structure, conduct & performance?
-Concentration and profits determined simultaneously, low cost producers have high market shares and mark-ups.
-Competition reduces profits, which discourages entry: competitive industries can be very concentrated.
-Structure is often not exogenous: entry barriers can be endogenous (e.g. advertising)
What is the Bresnahan equation encompassing all market structures?
P(Q) = MC - λQP’(Q)
What is the intuition behind Bresnahan’s equation?
When elasticity changes, we get different responses: firms pricing close to 𝑀𝐶 will not react to changes in price sensitivity, while firms with some degree of market power will adjust prices and quantities
