nep-com New Economics Papers
on Industrial Competition
Issue of 2006‒11‒18
25 papers chosen by
Russell Pittman
US Department of Justice

  1. Cartels and Search By Ireland, Norman; Waterson, Michael
  2. Mergers and Government Policy By Margarita Sapozhnikov
  3. One-Way Essential Complements By M. Keith Chen; Barry J. Nalebuff
  4. Downstream Research Joint Venture with Upstream Market Power By Constantine Manasakis; Emmanuel Petrakis
  5. Upstream Horizontal Mergers, Bargaining and Vertical Contracts By Chrysovalantou Miliou; Emmanuel Petrakis
  6. Bailouts in a common market: a strategic approach By Ela Glowicka
  7. Cross-Border Mergers & Acquisitions: The Facts as a Guide for International Economics By Steven Brakman; Harry Garretsen; Charles van Marrewijk
  8. Does Greater Competition Increase R&D Investments? Evidence from a Laboratory Experiment By Dario Sacco; Armin Schmutzler
  9. Does Deregulation Change Economic Behavior of Firms? By Subal Kumbhakar; Efthymios Tsionas
  11. Alliances between competitors and consumer information By Paolo Garella; Martin Peitz
  12. comparative Advertising By Simon P. Anderson; Régis Renault
  13. Minimum Quality Standards and Consumers Information By Paolo Garella; Emmanuel Petrakis
  14. Reference Pricing of Pharmaceuticals By Kurt R. Brekke; Ingrid Königbauer; Odd Rune Straume
  15. Multimarket spatial competition in the Colombian deposit market By Dairo Estrada; Sandra Rozo
  16. Product Differentiation and Film Programming Choice: Do First-Run Movie Theatres Show the Same Films? By Darlene C. Chisholm; Margaret S. McMillan; George Norman
  17. Health Insurance as a Two-Part Pricing Contract By Darius Lakdawalla; Neeraj Sood
  18. The Effect of Wal-Mart Supercenters on Grocery Prices in New England By Richard J. Volpe III; Nathalie Lavoie
  19. How to induce entry in railway markets: The German experience By Rafael Lalive; Armin Schmutzler
  20. Demand Elasticity and Market Power in the Spanish Electricity Market By Aitor Ciarreta; Maria Paz Espinosa
  21. The Degree of Competition in the Thai Banking Industry before and after the East Asian Crisis By Kubo, Koji
  22. Newspapers market shares and the theory of the circulation spiral By J. J. Gabszewicz; Paolo Garella; N. Sonnac
  23. Asymmetric Information and the Mode of Entry In Foreign Credit Markets By Eric Van Tassel; Sharmila Vishwasrao
  24. Market Power, Innovative Activity and Exchange Rate Pass-Through By Sophocles N. Brissimis; Theodora S. Kosma
  25. European Pharmaceutical Price Regulation, Firm Profitability, and R&D Spending By Joseph H. Golec; John A. Vernon

  1. By: Ireland, Norman (University of Warwick); Waterson, Michael (University of Warwick)
    Abstract: This paper unifies two significant but somewhat contradictory ideas. First, search costs potentially influence market price equilibria significantly; in many equilibria consumers do not search despite above-competitive prices. Second, cartels must guard against individual members offering lower prices, thereby creating incentives for consumers to search. We develop a simple framework, and then an example, in which whether search takes place depends upon the magnitude of search costs. Three potential equilibria result, dependent upon model parameters. These include a tacit cartel agreement exhibiting price variance and volatility. A policy conclusion is that such market characteristics do not always guarantee non-cartelisation.
    Date: 2006
  2. By: Margarita Sapozhnikov (Boston College)
    Abstract: It has long been thought that government antitrust policy has an effect on aggregate merger and acquisition activity, but the empirical support for this hypothesis has been weak and inconsistent. This paper uses a new empirical specification and a new dataset on mergers and acquisitions to provide support for this conjecture. Regression analysis shows that government policy has a significant influence on mergers and that the nature of the effects depends on the type of merger. Fitting the time series into a two-state Markov switching model shows that conglomerate and horizontal time series fol low different dynamics for the last half century, which is most likely caused by the dissimilar treatment of the two types of merger by the government. Only the conglomerate merger and acquisition time series is well described by a two-state Markov switching model. In contrast, the horizontal time series has a break in the early 1980s that may be attributed to the dramatic change in government policy.
    Keywords: Antitrust enforcement, mergers and acquisitions, time series models, Markov switching
    JEL: L40 K21 C32 C50
    Date: 2006–11–14
  3. By: M. Keith Chen (Yale School of Management, Yale University); Barry J. Nalebuff (Yale School of Management, Yale University)
    Abstract: While competition between firms producing substitutes is well understood, less is known about rivalry between complementors. We study the interaction between firms in markets with one-way essential complements. One good is essential to the use of the other but not vice versa, as arises with an operating system and applications. Our interest is in the division of surplus between the two goods and the related incentive for firms to create complements to an essential good. Formally, we study a two-good model where consumers value A alone, but can only enjoy B if they also purchase A. When one firm sells A and another sells B, the firm that sells B earns a majority of the value it creates. However, if the A firm were to buy the B firm, it would optimally charge zero for B, provided marginal costs are zero and the average value of B is small relative to A. Hence, absent strong antitrust or intellectual property protections, the A firm can leverage its monopoly into B costlessly by producing a competing version of B and giving it away. For example, Microsoft provided Internet Explorer as a free substitute for Netscape; in our model, this maximizes Microsoft's joint monopoly profits. Furthermore, Microsoft has no incentive to raise prices, even if all browser competition exits. This may seem surprising since it runs counter to the traditional gains from price discrimination and versioning. We also show that a essential monopolist has no incentive to degrade rival complementary products, which suggests that a monopoly internet service provider will offer net neutrality. There are other means for the essential A monopolist to capture surplus from B. We consider the incentive to add a surcharge (or subsidy) to the price of B, or to act as a Stackelberg leader. We find a small gain from pricing first, but much greater profits from adding a surcharge to the price of B. The potential for A to capture B's surplus highlights the challenges facing a firm whose product depends on an essential good.
    Keywords: Bundling, Complements, Monopoly leverage, Net neutrality, Price discrimination, Tying, Versioning
    JEL: C7 D42 D43 K21 L11 L12 L13 L41 M21
    Date: 2006–11
  4. By: Constantine Manasakis (Department of Economics, University of Crete, Greece); Emmanuel Petrakis (Department of Economics, University of Crete, Greece)
    Abstract: In this paper, we examine how the structure of an imperfectly competitive input market affects final-good producers’ incentives to form a Research Joint Venture (RJV), in a differentiated duopoly where R&D investments exhibit spillovers. Although a RJV is always profitable, downstream firms’ incentives for R&D cooperation are non-monotone in the structure of the input market, with incentives being stronger under a monopolistic input supplier, whenever spillovers are low. In contrast to the hold-up argument, we also find that under non-cooperative R&D investments and weak free-riding, final-good producers invest more when facing a monopolistic input supplier, compared with investments under competing vertical chains. Integrated innovation and competition policies are also discussed.
    Keywords: Oligopoly; Process Innovations, Research Joint Ventures
    JEL: L13 O31
    Date: 2005–09
  5. By: Chrysovalantou Miliou (Department of Economics, Universidad Carlos III de Madrid, Calle Madrid 126, Getafe (Madrid)); Emmanuel Petrakis (Department of Economics, University of Crete, Greece)
    Abstract: Contrary to the seminal paper of Horn and Wolinsky (1988), we demonstrate that upstream firms, which sell their products to competing downstream firms, do not always have incentives to merge horizontally. In particular, we show that when bargaining takes place over two-part tariffs, and not over wholesale prices, upstream firms prefer to act as independent suppliers rather than as a monopolist supplier. Moreover, we show that horizontal mergers can be procompetitive, even in the absence of efficiency gains.
    Keywords: horizontal mergers; bargaining; vertical relations; two-part tariffs; wholesale
    JEL: L41 L42 L22
    Date: 2005–03
  6. By: Ela Glowicka (Wissenschaftszentrum Berlin, Reichpietschufer 50, 10785 Berlin, Germany.
    Abstract: Governments in the EU grant Rescue and Restructure Subsidies to bail out ailing firms. In an international asymmetric Cournot duopoly we study effects of such subsidies on market structure and welfare. We adopt a common market setting, where consumers from the two countries form one market. We show that the subsidy is positive also when it fails to prevent the exit. The reason is a strategic effect, which forces the more efficient firm to make additional cost-reducing effort. When the exit is prevented, allocative and productive efficiencies are lower and the only gaining player is the rescued firm.
    Keywords: subsidies, asymmetric oligopoly, exit, European Union
    JEL: F13 L13 L52
    Date: 2005–10
  7. By: Steven Brakman; Harry Garretsen; Charles van Marrewijk
    Abstract: Using a detailed and large data set on cross-border merger and acquisitions we discuss the relationship between theory and observed empirical characteristics: (i) most FDI is in the form of M&As, (ii) firms engaged in M&As seem to be ‘market-seeking’, (iii) M&As come in waves (the most recent wave is still unfolding), (iv) economic integration (international deregulation) stimulated M&As, (v) the size of and inequality between M&As grows over time. Our contention in this chapter is that these stylized facts drive and should drive recent theoretical contributions in the field of international economics that try to understand cross-border mergers and acquisitions. Although some models (notably Neary, 2003) explain a number of the characteristics, a full-fledged model of cross-border M&As that, at least in principle, can deal with all the characteristics is still lacking.
    JEL: F23
    Date: 2006
  8. By: Dario Sacco (Socioeconomic Institute, University of Zurich); Armin Schmutzler (Socioeconomic Institute, University of Zurich)
    Abstract: Using an experiment based on two-stage games, we analyze the effects of competitive intensity on firms’ incentives to invest in process innovations. The experiment suggests that intense competition is favorable to investments.
    Keywords: R&D investment, intensity of competition, experiment
    JEL: C92 L13 O31
    Date: 2006–11
  9. By: Subal Kumbhakar (Department of Economics, State University of New York, USA); Efthymios Tsionas (Department of Economics, Athens University of Economics and Business, Greece)
    Abstract: Cost minimization and profit maximization behavioral assumptions are most widely used in microeconomic theory to analyze firm behavior. However, in practice researchers do not know whether every firm in the sample maximizes profit or minimizes cost. In this paper we address this problem via a latent class modeling approach in which we first consider the cost minimization problem (first class) and then the profit maximization problem (second class). The two problems are then mixed and the probabilities of class membership are made functions of covariates. This approach does not require researchers to know which firms maximize profit and which ones minimize cost. On the contrary, it helps us to determine not only which firms behave like profit maximizers but also why and what differentiates them from firms that failed to maximize profit. The new technique is illustrated using a panel data for the US airlines. The empirical findings suggest that very few airlines maximize profit consistently (if at all) and that deregulation had a positive impact on the chances of behaving like profit maximizers, although very few airlines continue to maximize profit even after the deregulation.
    JEL: N
  10. By: Chrysovalantou Milliou
    Abstract: We examine firms' incentives to protect their non-cooperative R&D investments from spilling over to competitors. Contrary to most of the existing literature, we show that the lack of full appropriability can lead to an increase in R&D investments. We also show that even if protection is costless, firms sometimes choose to let their R&D investments unprotected. Our welfare analysis indicates that public policies that promote the dissemination of technological knowledge should be adopted.
    Date: 2006–11
  11. By: Paolo Garella (University of Milano, Italy); Martin Peitz (International University in Germany, Bruchsal (Germany))
    Abstract: Alliances between competitors in which established firms provide access to proprietary resources, e.g. their distribution channels, are important business practices. We analyze a market where an established firm, firm A, produces a product of well-known quality, and a firm with an unknown brand, firm B, has to choose to produce high or low quality. Firm A observes firm B's quality choice but consumers do not. Hence, firm B is subject to a moral hazard problem which can potentially be solved by firm A. Firm A can accept or reject to form an alliance with firm B, which is observed by consumers. If an alliance is formed, firm A implicitly certifies the rival's product. Consumers infer that firm B is a competitor with high quality, as otherwise why would the established firm accept to form an alliance? The mechanism we discover allows for an economic interpretation of several types of business practices.
    Keywords: alliances, brand sharing, asymmetric information, signaling, exclusion, moral hazard, entry assistan
    JEL: L15 L13 L24 L42
    Date: 2006–00–01
  12. By: Simon P. Anderson (Department of Economics, University of Virginia); Régis Renault (Université de Cergy-Pontoise (Théma))
    Abstract: Consumer information on products affects competition and profits. We analyze firms' decisions to impart product information through advertising: comparative advertising also allows them to impart information about rivals' products. If firms sell products of similar qualities, both want to advertise detailed product information that enables consumers to determine their matches: there is no role for comparative advertising. If qualities are sufficiently dissimilar, the high-quality one will not want to disclose match information. If legal, the low-quality firm rival would like to advertise match information about its rival. Such "comparative" advertising may have a detrimental impact on welfare by leading more consumers to consume the low quality product: this effect can dominate the benefits from improved consumer information and reduce social welfare if qualities are different enough.
    Keywords: comparative advertising, information, product differentiation, quality
    JEL: D42 L15 M37
    Date: 2006
  13. By: Paolo Garella (University of Milano, Italy); Emmanuel Petrakis (Department of Economics, University of Crete, Greece)
    Abstract: The literature so far has analyzed the effects of Minimum Quality Standards in oligopoly, using models of pure vertical differentiation, with only two firms, and perfect information. We analyze products that are differentiated horizontally and vertically, with imperfect consumers information, and more than two firms. We show that a MQS changes the consumers’ perception of produced qualities. This increases the firms’ returns from quality enhancing investments, notwithstanding contrary strategic effects. As a consequence, MQS policies may be desirable as both, firms and consumers, can gain. This contrasts with previous results in the literature and provides a justification for the use of MQS to improve social welfare.
    Keywords: Minimum Quality Standards, Imperfect Consumer Information,
    JEL: L0 L5
    Date: 2005–02–16
  14. By: Kurt R. Brekke; Ingrid Königbauer; Odd Rune Straume
    Abstract: We consider a therapeutic market with potentially three pharmaceutical firms. Two of the firms offer horizontally differentiated brand-name drugs. One of the brand-name drugs is a new treatment under patent protection that will be introduced if the profits are sufficient to cover the entry costs. The other brand-name drug has already lost its patent and faces competition from a third firm offering a generic version perceived to be of lower quality. This model allows us to compare generic reference pricing (GRP), therapeutic reference pricing (TRP), and no reference pricing (NRP). We show that competition is strongest under TRP, resulting in the lowest drug prices (and medical expenditures). However, TRP also provides the lowest profits to the patent-holding firm, making entry of the new drug treatment least likely. Surprisingly, we find that GRP distorts drug choices most, exposing patients to higher health risks.
    Keywords: pharmaceuticals, reference pricing, product differentiation
    JEL: I11 L13 L51 L65
    Date: 2006
  15. By: Dairo Estrada; Sandra Rozo
    Abstract: This paper presents a multimarket spatial competition oligopoly model for the Colombian deposit market, in line with the New Empirical Industrial Organization (NEIO) approach. In this framework, banks use price and non-price strategies to compete in the market, which allows us to analyze the country and the regional competitiveness level. The theoretical model is applied to quarterly Colombian data that covers the period between 1996 and 2005. Our results suggest that, although the country deposit market appears to be more competitive than the Nash equilibrium, there are some local areas within the country that present evidence of market power.
    Keywords: Banking; Location; Competition; Colombia. Classification JEL: D4; G21; L13; R12.
  16. By: Darlene C. Chisholm; Margaret S. McMillan; George Norman
    Abstract: We present an empirical analysis of product differentiation using a new dynamic panel data set on film programming choice in a major U.S. metropolitan motion-pictures exhibition market. Using these data, we compute two measures of film programming choice which allow us to investigate the determinants of strategic product differentiation in a multi-characteristics space. Our evidence is consistent with the idea that the degree of product differentiation between theatre pairs reflects a balance between strategic concerns and contractual constraints. Similarity in one dimension is offset by differentiation in others. Finally, we find that ownership matters: theatres under common ownership make more similar programming choices than theatres with different owners.
    JEL: C33 L11 L82
    Date: 2006–10
  17. By: Darius Lakdawalla; Neeraj Sood
    Abstract: Monopolies appear throughout health care markets, as a result of patents, limits to the extent of the market, or the presence of unique inputs and skills. In the health care industry, however, the deadweight costs of monopoly may be small or even absent. Health insurance, frequently implemented as an ex ante premium coupled with an ex post co-payment per unit consumed, effectively operates as a two-part pricing contract. This allows monopolists to extract consumer surplus without inefficiently constraining quantity. This view of health insurance contracts has several implications: (1) Low ex post copayments to insured consumers substantially reduce deadweight losses from medical care monopolies -- we calculate, for instance, that the presence of health insurance lowers monopoly loss in the US pharmaceutical market by 82 percent; (2) Price regulation or break-up of health care monopolies may be inferior to laissez-faire or simple redistribution of monopoly profits; and (3) Promoting efficiency in the health insurance market can reduce static losses in the goods market while improving the dynamic efficiency of innovation.
    JEL: D42 I11
    Date: 2006–11
  18. By: Richard J. Volpe III (Department of Agricultural and Resource Economics, University of California at Davis); Nathalie Lavoie (Department of Resource Economics, University of Massachusetts Amherst)
    Abstract: This study examines the competitive price effect of Wal-Mart Supercenters on national brand and private label grocery prices in New England. For this purpose, we use primary price data collected on a basket of identical products from six Supercenters in Massachusetts, Connecticut, and Rhode Island as well as a sample of conventional supermarkets. Taking into account demographics, store characteristics, and market conditions, we estimate the average prices charged by (1) Supercenters, (2) supermarkets competing directly with Supercenters, and by (3) supermarkets geographically distant from Supercenters. By comparing prices at competing stores and at distant stores, we show that the effect of Wal-Mart Supercenters is to decrease prices by 6 to 7 percent for national brand goods and 3 to 7 percent for private label goods. Price decreases are most significant in the dry grocery and dairy departments. Moreover, Wal-Mart sets prices significantly lower than its competitors in the food industry.
    Keywords: Wal-Mart; Supermarket Competition; Grocery Prices; National Brands, Private Labels
    JEL: D21 D43 L11 L13 L81
    Date: 2006–10
  19. By: Rafael Lalive (HEC Lausanne, University of Lausanne); Armin Schmutzler (Socioeconomic Institute, University of Zurich)
    Abstract: In Germany, competitive franchising is increasingly being used to procure passenger railway services. This paper analyzes the 77 tenders that have taken place since the railway reform in 1994. The tenders differ with respect to the size of the franchise network, the required frequency of service, the duration of the contract and the proximity to other lines that are already run by competitors of DB Regio, a subsidiary of the successor of the former state monopolist. Our analysis shows that larger networks are less likely to be won by the competitors. Also, more recent auctions have been won by competitors more frequently than earlier auctions. Other control variables such as the duration of the contract and the adjacency to other lines run by entrants are insignificant.
    Keywords: Competition for the market, liberalization, passenger railways, procurement auctions
    JEL: D43 D44 R48
    Date: 2006–11
  20. By: Aitor Ciarreta (Departamento de Fundamentos del Analisis Economico II, Universidad del Pais Vasco); Maria Paz Espinosa (Departamento de Fundamentos del Analisis Economico II, Universidad del Pais Vasco)
    Abstract: In this paper we check whether generators' bid behavior at the Spanish wholesale electricity market is consistent with the hypothesis of pro?fit maximization on their residual demands. Using OMEL data, we ?find the arc-elasticity of the residual demand around the system marginal price. The results suggest that the larger ?firms are not actually pro?fit-maximizing on their residual demands while smaller generators' behavior is consistent with profit maximization. We argue how the regulatory environment may drive these results. Finally, we repeat the analysis for the ?first session of the intra-day market where presumably ?firms may not have the same incentives as in the day-ahead market
    Keywords: market power, electricity market, residual demand elasticity, pro?fit maximization
    JEL: L11 L13 L51
    Date: 2006–07
  21. By: Kubo, Koji
    Abstract: This paper analyzes the influence of the East Asian crisis and the subsequent reforms on the oligopolistic nature of the Thai banking industry. Since the crisis, there have been substantial changes in competitive environment, including a decline in the family ownership of banks as well as the arrival of new entrants. How did these changes affect a banking industry in which the six largest local banks accounted for over 70 percent of market share? The estimated Lerner index from Bresnahan's [1989] conjectural variation model indicates the possibility of a decline in the degree of competition.
    Keywords: Thai banking industry, Degree of competition, Lerner index, Banks, Financial crises, Thailand
    JEL: L13 G21
    Date: 2006–03
  22. By: J. J. Gabszewicz (CORE, Universit´e Catholique de Louvain); Paolo Garella (University of Milano, Italy); N. Sonnac (CREST-LEI and Universit´e Paris II)
    Abstract: We consider a model of daily newspapers’ competition to test the validity of the so called ”theory of the circulation spiral”. According to it, the interaction between the newspapers and the advertising markets drives the newspaper with the smaller readership into a vicious circle, finally leading it to death. In a model with two newspapers, we show that, contrary to this conjecture, the dynamics envisaged by the proposers of the theory, does not always lead to the elimination of one of them.
    Date: 2005–11–05
  23. By: Eric Van Tassel (Department of Economics, College of Business, Florida Atlantic University); Sharmila Vishwasrao (Department of Economics, College of Business, Florida Atlantic University)
    Abstract: In a newly liberalized credit market, foreign banks with cost advantages are likely to be less informed than domestic banks that hold information on credit risks. These relative advantages may generate incentives for a foreign bank to negotiate acquisition of a domestic bank in order to capture information endowments. However, if it is difficult to assess the value of information held by banks, the foreign bank will face important choices about the optimal mode of entry and what acquisition price to pay. These choices have implications for the survival of domestic banks and how capital is allocated after liberalization.
    Keywords: Foreign entry, bank competition, information
    JEL: G21 D82
    Date: 2006–08
  24. By: Sophocles N. Brissimis (Bank of Greece, Economic Research Department and University of Piraeus); Theodora S. Kosma (Bank of Greece, Economic Research Department)
    Abstract: This paper considers an international oligopoly where firms simultaneously choose both the amount of output produced and the proportion of R&D investment to output. The model captures the links between the exchange rate, market power, innovative activity and price, which are important for the determination of the optimal degree of exchange rate pass-through. It is found that in the long run the pass-through elasticity can be less than, equal to or greater than one depending on R&D effectiveness but in any case it is higher than in models that do not endogenise innovation decisions. The empirical implications of the model are tested using data for Japanese firms exporting to the US market and applying the Johansen multivariate cointegration technique. Particular attention is given to the estimation and identification of the equilibrium price and R&D-intensity equations. The empirical results indicate that price-setting and R&D-intensity decisions of firms are jointly determined in the long run. This interdependence must be taken into account if an accurate estimate of the exchange rate pass-through is to be obtained.
    Keywords: Exchange rate pass-through; market power; innovative activity; multivariate cointegration
    JEL: C32 F39 L13 O31
    Date: 2005–04
  25. By: Joseph H. Golec; John A. Vernon
    Abstract: EU countries closely regulate pharmaceutical prices whereas the U.S. does not. This paper shows how price constraints affect the profitability, stock returns, and R&D spending of EU and U.S. firms. Compared to EU firms, U.S. firms are more profitable, earn higher stock returns, and spend more on research and development (R&D). Some differences have increased over time. In 1986, EU pharmaceutical R&D exceeded U.S. R&D by about 24 percent, but by 2004, EU R&D trailed U.S. R&D by about 15 percent. During these 19 years, U.S. R&D spending grew at a real annual compound rate of 8.8 percent, while EU R&D spending grew at a real 5.4 percent rate. Results show that EU consumers enjoyed much lower pharmaceutical price inflation, however, at a cost of 46 fewer new medicines introduced by EU firms and 1680 fewer EU research jobs.
    JEL: I11 I18 K2 O34
    Date: 2006–11

This nep-com issue is ©2006 by Russell Pittman. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.