Does firm exit increase prices?
46 Pages Posted: 11 Mar 2020 Last revised: 19 Oct 2020
Date Written: October 17, 2020
This paper studies how market structure and product market concentration affect prices. It is a difficult question to answer because market structure and prices are determined endogenously. Therefore, I focus on exit and use an instrumental variable approach to identify the price effect of exit in Swedish firm-level micro data. The instrument for firm exit is defined as the connection of firms to a bank that was severely affected by the financial crisis through its subsidiaries abroad. For this instrument to work, I argue that the instrumental variable only changed the market structure via exit for reasons that were unconnected to the remaining incumbent firms' production costs. The instrumental variable regression shows that firms increase their prices by 0.3 percent when one percent of their competitors exit. I compare the estimated coefficient to predictions from a quantitative model with variable markups. The effect of exit is much larger in the data than in the model. I show that the model can be brought into line with the data under the assumption that industries are divided into sub-markets, following definitions about markets from the industrial organization literature.
Keywords: competition, firm price setting, inflation
JEL Classification: D44, E31, G01, L11
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