How (not) to measure competition

Jan Boone is currently working on the project "How (not) to measure competition". In a paper co-authored with Jan van Ours and Henry van der Wiel (CPB), three measures of competition are considered. Two of these (concentration and price cost margin) are well-known, but may be misleading: more intense competition can lead to higher industry concentration and higher average price cost margins. In such cases, these measures incorrectly suggest that competition diminished, while actually it increased. The third measure is new and does not have these problems. It is based on the elasticity of profits with respect to cost: by what percentage do firms' profits fall in response to a 1% increase in costs. If this elasticity is high, competition is intense: firms are punished more harshly for a loss in efficiency. It turns out that, on average this elasticity is around 7 for Dutch industries. However, there is quite a bit of variance: in some industries it is bigger than 20, in others it is close to 0. In general, it is higher in manufacturing than in services. The paper also shows that under certain conditions there is no correlation between the traditional measures of competition and the elasticity that is estimated. For further information you may contact Jan Boone.