Thursday, March 24, 2011

The First-Order Approach to Merger Analysis

Posted by D. Daniel Sokol

Sonia Jaffe, Harvard University - Department of Economics and Eric Glen Weyl, Harvard University - Society of Fellows, Toulouse School of Economics offer The First-Order Approach to Merger Analysis.

ABSTRACT: In a general static oligopoly setting, we derive approximations to the changes in prices and welfare generated by a merger using only information local to the pre-merger equilibrium. Our Generalized Pricing Pressure (GePP) extends the Upward Pricing Pressure (UPP) of Werden (1996), Farrell and Shapiro (2010a) and the new US and UK horizontal merger guidelines to allow for non-Bertrand conduct and general cost functions. GePP differs from UPP in two ways: it uses the appropriate diversion ratio when other prices do not stay constant and incorporates the change in accommodating reactions sparked by the merger. The effect this pricing pressure has on prices is determined by the merger pass-through matrix, a mixture of the pre- and post-merger rates at which changes in marginal costs are passed through to prices. We show the conditions under which merger pass-through is close to both post-merger pass-through and, more importantly for implementation, pre-merger pass-through. The resulting change in prices can be converted into estimates of changes in welfare and consumer surplus. Our analysis thus demonstrates that the “first-order” approach underlying the new guidelines, with some adjustments, provides a robust quantitative approximation to the consumer surplus effects of mergers. It also illustrates how, more generally, apparently discrete changes (such as mergers) that have small effects on relevant outcomes may be approximated by classical comparative statics methods.

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