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Review of Industrial Organization

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23.01.2020

Pricing and Industry Structure when Demand Elasticity Changes

verfasst von: Jean-Paul Chavas, Guanming Shi, Kyle Stiegert

Erschienen in: Review of Industrial Organization | Ausgabe 4/2020

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This paper examines the economics of pricing under imperfect competition. It studies how industry concentration interacts with the elasticity of demand to affect pricing. When the demand elasticity decreases with increased market concentration, it can have significant effects on pricing. This issue is investigated empirically in an analysis of the determinants of nitrogen fertilizer prices in the US. The U.S. nitrogen fertilizer industry is an interesting case study for two reasons: First, it has exhibited increasing concentration over the last few decades. Second, the elasticity of U.S. demand for nitrogen fertilizer has decreased over that time period. Our analysis documents how a more inelastic demand for fertilizer—in addition to increased market concentration—has contributed to higher fertilizer prices.

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Demand elasticities can also play a role in strategic behavior (Tirole 1988) and price discrimination schemes (Stole 2007). One such example is the case of advertising. Besides informing consumers about quality and price, advertising reduces consumer search among competing products, which decreases the price sensitivity of demand (Bagwell 2007). It follows that advertising has directly linkages with demand elasticity (Dorfman and Steiner 1954).

The price index of other farm inputs \( P_{t}^{i} \) was calculated as a Fisher price index with the use of information provided by USDA (2018b).

The analysis presented below measures \( P_{t}^{o} \) as a price index for all U.S. agricultural outputs (USDA 2018b). We also conducted the econometric analysis measuring \( P_{t}^{o} \) as a price index for U.S. crop outputs. The empirical results were very similar to the ones reported below, yielding the same qualitative findings.

From the same sources, we also obtained data on the \( CR4 \) index that measures the summed market share of the top four firms in the U.S. urea market. The \( CR4 \) doubled during the sample period: The aggregate market share of the top-four firms went from about 0.42 in the 1960’s to 0.86 in the 2010’s. While the estimates reported below rely on the \( HHI \), we did use the \( CR4 \) in our robustness check analysis.

Equation (4) assumes that farmers are price takers: They decide fertilizer use while taking the fertilizer price \( P_{t}^{f} \) as given.

We also explored specifying and estimating Eq. (6) using nominal prices. In this context, after adding CPI as an explanatory variable, we tested whether Eq. (6) is linear homogeneous in prices. Using bootstrapped standard errors, the p value for this test was 0.440, thus supporting the use of real prices in Eq. (6).

In our double-log specification, imposing restriction (3) in Eq. (6) amounts to including \( \left( {HHI/E} \right) \) as an explanatory variable in (6).

We also explored alternative specifications that are related to the role of trade in domestic pricing. They did not show evidence that greater imports reduced the price-enhancing effects of high industry concentration. This issue of trade effects on pricing under imperfect competition seems to be a good topic for further research.

The estimates obtained from alternative model specifications are available from the authors upon request.

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Titel: Pricing and Industry Structure when Demand Elasticity Changes
verfasst von: Jean-Paul Chavas
Guanming Shi
Kyle Stiegert
Publikationsdatum: 23.01.2020
Verlag: Springer US
Erschienen in: Review of Industrial Organization / Ausgabe 4/2020
Print ISSN: 0889-938X
Elektronische ISSN: 1573-7160
DOI: https://doi.org/10.1007/s11151-019-09745-y

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