Pricing and Market Concentration: A New Estimation Strategy

Posted by D. Daniel Sokol

Michael J. Doane, Competition Economics LLC, Luke Froeb, Vanderbilt University - Owen Graduate School of Management, Gregory J. Werden, U.S. Department of Justice - Antitrust Division, and David M. Zimmer, Western Kentucky University - Department of Economics address Pricing and Market Concentration: A New Estimation Strategy.

ABSTRACT: Estimation of the effect of competition on prices is complicated by entry: High prices and profits attract entry, which reduces market concentration and prices. Regressing price on concentration, therefore, picks up both the effect of concentration on prices and the confounding effect of prices on concentration. This paper addresses this endogeneity problem by constructing an estimator that utilizes only variation in ownership concentration, while holding entry constant. The estimator is applied to the rental car industry, in which past mergers have created multi-brand firms. Despite significant market segmentation, overall market concentration, rather than segment concentration, explains rental car pricing. The estimated effect of concentration on prices is found to be roughly what simple theoretical models predict, and this estimate is used to predict the price effects of two recently proposed car rental mergers.