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Price Elasticity Analysis: Theorie and Applications

Skaidr te brama, Competition Council of Latvia


TAIEX Workshop on Competition Policy Tirana, October 7, 2010

Overwiev ----------------------------------------------Price elasticities -- underlying concepts


Market definition investigation and SSNIP Economic interpretation

Practical application
Qualitative tools Latvian beer inquiry, 2009 Quantitative -- COMP/M.5046 Campina/Friesland

Conclusions

Market definition investigation (SSNIP) ---------------------------------------------------

Would a hypothetical monopolist (the only seller of bananas, the only Brussels-Frankfurt flight route provider) find it profitable to increase the price above current level in a non-transitory way by 510%? ? - Are there other fruits substitutable to bananas (United Brands v. Commission (27/76)) ? - Are there other travel possibilities (e.g., fast-speed train) substitutable to Lufthansa SN Airholding flight from Brussels to Frankfurt (COMP/M. 5335 Lufthansa/
SN Airholding)

SSNIP test s implementation tools --------------------------------------------------Price elasticities Own-price elasticity


Critical elasticity analysis

Cross-price elasticity Price concentration studies Price correlation tests Price differences Shock analysis, etc.

Own-price elasticity of demand

--------------------------------------------------Percentage change in quantity demanded that follows a 1%


increase in product price: = - ( q/q)/( p/p), where
q and p are quantities and prices of the product; is difference between level of variable after and before the change The fraction should be multiplied by -1, to define elasticity in positive numbers.

Critical elasticity = estimates of the maximum own-price elasticity of demand that would still make an increase in price profitable.
Sometimes selling a smaller quantity at a higher price would be more profitable than selling a larger quantity at a lower price.

HM could profitably raise prices by proportion t, only if ownprice elasticity is less than critical elasticity < (1+t)/(m+t), where
t proportional rise in price, m current price-cost margin (p-c)/p.

Measuring price elasticity of demand


--------------------------------------------------------------p > 1 (elastic or sensitive to price changes) Demand

= 1 (unitary revenue constant ) < 1 (inelastic)

How to define a relevant market?


If = 0,2% is the price rise by 10% profitable?

Measuring price elasticity of demand --------------------------------------------------Various variables affect demand of a given product
Prices and availability of other products General price level, disposable income, etc.

Data necessary for measuring PEoD


Qualitative
Customer surveys (If the price for product would increase by 10% would you switch to which product would you switch?), questionnaires to competitors (If the price for product would increase by 10% would you start production? etc.) Own-price

elasticity
Already available information (internal documents, market studies)

Quantitative -- econometric analysis of demand reactions following price changes (necessary to have real datas costs, margins) Cross-price elasticity

Cross-price elasticity --------------------------------------------------Measures an impact of price changes of one product on the demand for another product

Percentage change in the demand for product B when there is 1% increase in the price of product A:
AB

= ( qB/qB)/( pA/pA) >0 products are substitutes <0 products are complements

Economic interpretation

=0 products are not in the same market Note: despite own-price elasticity for the product A stated that hypothetical monopolist would not profitably rise price of A in a small but significant way, cross-price elasticity might help to identify the products exercising constraint on A (the closest substitutes) .

Latvian experience -- PEoD --------------------------------------------------Beer market inquiry, 2009


Similarities in price movements of two largest beer producers Assessing the risk of (tacit) collusion and coordinated behaviour in the beer market Market definition: premium and standard beer -- separate or one market?

Qualitative investigatory tools


Understanding of products, their characteristics Analysing precedents in other authorities and EC (EC COMP/M. 2740 Scottish&Newcastle/Hartwall, COMP/M. Heineken/Bayerische Brauholding/JV, COMP/M. 4999 Heineken/Scottish&Newcastle assets) Questionnaires to beer producers and supermarkets Past and future business decisions (marketing documents, internal business analysis, customer survey submitted by largest beer producers) Analysing prices and their developments over 3 years period Analysing consumers behaviour, producers reaction

Quantitative tools cross-price elasticity?


Raw datas from largest supermarket chains on various beer sorts (scanner data), weekly information on price and quantity (at least 1 year), etc.

Beer market inquiry

--------------------------------------------------Conclusions
Premium and standard beer brands treated as one relevant product market. HoReCa and retail markets -- relevant product markets in the distribution of beer. The relevant geographic market defined as national in scope.

Lessons made
The application of econometric/quantitative techniques to the market definition analysis requires longer time-series data to conduct price correlation tests and market-level or cross-sectional/panel firm-level data to estimate a structural model for Latvian beer market, on the basis of which own- and cross-price elasticities may be obtained and in particular the critical loss test may be implemented. Low-price consumer products (beer) have negligible PEoD (inelastic demand) compared with more expensive ones PEoD is not constant: for cheaper products PEoD tend to vary over time in the long run PEoD will be much higher than in the short run. PE of supply depends on (free) capacities of producers, entry barriers and many other factors determining whether they can react quickly to price increase or not.

Case COMP/M.5046 Campina/Friesland

-------------------------------------------------Merger of two independent dairy cooperatives, based in Netherlands and


operating worldwide Horizontal overlaps in many markets: procurement of raw milk, fresh basic dairy products (e.g. frish milk and yogurt), fresh and long-life flavoured dairy drinks, cheese A case with unusually large number of difficult issues calling for economic evidence :
Geographic market definition procurement market scope: national, narrower or beyond the Netherlands Significance of supply-side substitutability in product market delineation, etc. An example: 560. The following markets will be assessed hereinafter: (i) sale of Dutch-type cheese to specialised cheese wholesalers; (ii) sale of Dutch-type cheese to modern types of retail; (iii) sale of nature Dutch-type cheese to specialised cheese wholesalers; (iv) sale of 15-day-old nature Dutch-type cheese to specialised cheese wholesalers (v) sale of nature Dutch-type cheese to modern types of retail; (vi) sale of rindless Dutch-type cheese to specialised cheese wholesalers; and (vii) sale of rindless Dutch-type cheese to modern types of retail. Each of the markets referred to in (i) (vii) could also be defined more narrowly as only comprising Gouda or Maasdam respectively.

Measuring elasticities between products of merging parties

--------------------------------------------------Pricing (scanner) data indicated that the notifying parties brands are perceived as the closest competitors in the retail market
Estimations of matrix of demand elasticities for a set of product categories/ individual brands (14 product markets analysed)
For all major brands and private labels in various product categories fresh basic dairy ; fresh flavoured dairy drinks and long-life flavoured dairy drinks Also at higher level of aggregation e.g. across the four fresh basic dairy categories fresh milk, fresh yoghurt, buttermilk and custard in order to determine whether each categorie constitutes a distinct product market from demand side perspective or whether they form part of a wider fresh basic dairy market

Two basic demand models


the representative consumer model, estimated by specifying the appropriate demand system (functional specification based on AIDS, Q-AIDS, Translog), and the address or location based model, estimated with logit, nested logit, or random coefficient discrete choice models.

Econometric analysis uphold that parties products are closest competitors for all three categories of considered markets

Own- and cross-price elasticities estimation -------------------------------------------------Some stylized facts


Top level estimates: Flavored drinks. The fresh health segment has the lowest own price elasticities and is the least constrained by the other segments. It can be considered as a separate market. The long-life chocolate and long-life fruit segments have the highest own price elasticites and provide strong competitive constraints on each other.
FLAVOURED DAIRY PRODUCTS Estimator: FIXED EFFECTS SUR Demand Specification: AIDS / All brands aggregated by segment ____________________________________________________________________ FRESH FRESH LONG-LIFE LONGLIFE HEALTH OTHER CHOCO FRUIT -0.678*** 0.328*** 0.266*** 0.207*** FRESH_HEALTH FRESH_OTHER 0.305*** -1.542*** 0.549*** 0.414*** 0.972*** LONG_LIFE_CHOCO 0.647*** 1.038*** -2.459*** LONG_LIFE_FRUIT 0.451*** 0.797*** 1.000*** -2.285*** Note: *, **, *** - significantly different from zero at 10, 5, 1% level, respectively. ______________________________________________________________________________ Elasticities of flavoured products (from the Decision)

Commitments --------------------------------------------------It was concluded that concentration will lead to significant impediment of effective competition in many product markets Campina and Friesland Foods proposed commitments
"the third commitment proposal including the divestment of the entire fresh dairy business of Friesland Foods in the Netherlands (covering all fresh products); ownership acpects of many products brand names; divestment of Campina's cheese production facility; three elements aiming at ensuring access to raw milk for downstream competitors,etc.

Market test confirmed commitments submitted are sufficient to remove competition concerns identified in markets Commission concluded that market definitions presented in the Decision can be supported by other evidence and can be maintained without the econometric results.

Conclusions --------------------------------------------------Qualitative and quantitative tools may be used for defining markets and assessing elasticities. Their choice depends upon the data availability, purpose of the investigation, budget resources of the competition authority, etc. The quantitative analysis should rather complement the qualitative analysis, without giving any preference to any particular tool. Especially the application of quantitative tools is not always possible. An econometric estimation of own- and cross-price elasticities allthough done sufficiently robustly will not always assure withstanding of judicial scrutinity.

References ----------------------------------------------1. Bishop S. And Walker M., The Economics of EC Competition Law: Concepts, Application and Measurement, University Edition, 2010, Sweet&Maxwell by Thomson Reuters. Carlton D.W., Perloff J.M. Modern Industrial Organization, Second Edition, 1994, Harper Collins College Publishers. Motta M. Competition Policy: Theorie and Practice, 2008, Cambridge University Press. Case No COMP/M.5046 Friesland Foods /Campina (2008), JO C 075 Vol 52 of 31 March 2009.

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www.kp.gov.lv Skaidrite.Abrama@kp.gov.lv Phone: +371 67365220

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