Collaborative Research: Empirical Models of Supracompetitive Pricing in Differentiated Products Markets

Swarthmore College, Swarthmore PA

Investigators

Abstract

This research studies the magnitude and determinants of prices and price-cost margins, with lessons for merger enforcement and the detection of cartels. Most empirical research assumes prices are determined by firms' product portfolios, the extent to which consumers view products as differentiated, and, importantly, competition based solely on current market conditions. However, when firms expect to compete in the future and have sufficiently low discount rates, threats of future price wars can support higher prices than predicted by static pricing models. This project explores this theory in two ways. First, the investigators develop and estimate a repeated game model of oligopoly price leadership. The assumptions in the model are motivated by an industry practice where one firm proposes a markup to a coalition. The model is then used to understand how mergers change pricing incentives. Second, the investigators develop a test of static competition that is robust to how exactly firms set prices under the alternative hypothesis. This research illustrates both methodologies with empirical applications. This research characterizes equilibrium in the price leadership model, state conditions under which marginal costs can be recovered given data on prices, quantities, and demand estimates, and characterize conditions under which firms' implied time preferences can be identified. The investigators apply the model to the U.S. brewing industry and study how the Miller/Coors joint venture changed pricing incentives. The test for static Nash competition takes into account product differentiation and multi-product ownership by individual firms. This test is applied to the U.S. canned tuna market, where two of the three largest firms recently plead guilty to price fixing. This research shows how the framework can be used to i) date cartel operations, ii) distinguish cartel participants from firms that are simply pricing optimally given its competitors are colluding and iii) study the effectiveness of the cartel by comparing observed prices and variable profits to those that arise in Nash-Bertrand equilibrium and under joint profit maximization. This award reflects NSF's statutory mission and has been deemed worthy of support through evaluation using the Foundation's intellectual merit and broader impacts review criteria.