Measuring Competition

Abstract

We investigate the empirical usefulness of a new measure of the degree of competition in a market, proposed by Boone (2000). This measure is based on the reduction in profits that firms experience as a result of cost inefficiencies. We compare this with measures commonly used by policy makers and in empirical work - market shares, concentration indices, the Herfindahl index and price cost margins. Using simulated data we show that in markets where goods are symmetrically differentiated, and where firms differ in their marginal cost, traditional measures can be poor indicators of the degree of competition, while the new relative profits measure performs better. Using accounting data on UK firms we investigate the relationship between the relative profits measure and traditional measures. Our results suggest that concentration-based measures perform worst, while the relative profits measure may provide a useful empirical complement to price-cost margins in both policy and econometric analysis.