We present and compare various techniques for estimating market power – the ability to set price profitably above marginal cost – and strategies – game-theoretic plans used by firms to compete with rivals. We start by examining static model approaches to estimating market power. Then, we extend our market power analysis to dynamic models. Finally, we develop methods to estimate firms' strategies directly and examine how these strategies determine market power. Throughout, we emphasize that the type of study we undertake depends crucially on which variables are observed and on the unobserved strategies of firms.
Research on market power and strategies is important for both policy makers and academics. It provides evidence that policy makers can use to improve antitrust and merger laws. It is used in court cases – and presumably will be increasingly employed in the future. It also allows academics to test theoretical models that were previously accepted on faith.
THREE MAIN QUESTIONS
Throughout this book, we focus on three major questions:
(1) How much market power does a firm or industry exercise?
(2) What are the major factors that determine this market power?
(3) How do firms' strategies determine market power?
Whether one can observe a reliable measure of market power often determines how researchers proceed. For example, in a one-period market, if we can observe the price, p, charged and can observe or estimate the marginal cost, MC, we can provide a direct answer to the first question – how much market power is exercised – by measuring the gap between price and marginal cost.