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How (Not) to Measure Competition

TILEC Discussion Paper No. 2007-014

CentER Discussion Paper Series No. 2007-32

49 Pages Posted: 10 May 2007

See all articles by Jan Boone

Jan Boone

Tilburg University - Center for Economic Research (CentER); Centre for Economic Policy Research (CEPR); TILEC

Jan C. van Ours

Tilburg University - Department of Economics; University of Melbourne - Department of Economics

Henry van der Wiel

CPB Netherlands Bureau of Economic Policy Research

Multiple version iconThere are 2 versions of this paper

Date Written: April 2007

Abstract

We introduce a new measure of competition: the elasticity of a firm's profits with respect to its cost level. A higher value of this profit elasticity (PE) signals more intense competition. Using firm-level data we compare PE with the most popular competition measures such as the price cost margin (PCM). We show that PE and PCM are highly correlated on average. However, PCM tends to misrepresent the development of competition over time in markets with few firms and high concentration, i.e. in markets with high policy relevance. So, just when it is needed the most PCM fails whereas PE does not. From this we conclude that PE is a more reliable measure of competition.

Keywords: competition, profit elasticity, measures of competition, concentration, price cost margin, profits

JEL Classification: D43, L13

Suggested Citation

Boone, Jan and van Ours, Jan C. and Wiel, Henry van der, How (Not) to Measure Competition (April 2007). TILEC Discussion Paper No. 2007-014, CentER Discussion Paper Series No. 2007-32, Available at SSRN: https://ssrn.com/abstract=985270 or http://dx.doi.org/10.2139/ssrn.985270

Jan Boone (Contact Author)

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2399 (Phone)
+31 13 466 3042 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

TILEC ( email )

Warandelaan 2
Tilburg, 5000 LE
Netherlands

Jan C. Van Ours

Tilburg University - Department of Economics ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2880 (Phone)
+31 13 466 3042 (Fax)

University of Melbourne - Department of Economics ( email )

Melbourne, 3010
Australia

Henry van der Wiel

CPB Netherlands Bureau of Economic Policy Research ( email )

P.O. Box 80510
2508 GM The Hague, 2585 JR
Netherlands

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