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Market Definition Using Econometrics: An Apparent Paradox Explained
01 July 2004
Dr. Sumanth Addanki
Econometrics is the tool to which economists turn most often to address
questions that are empirical or quantitative in nature. However, to be
useful, an econometric study must be carefully designed, and the results
must be interpreted with skill.
In this chapter from Economics of Antitrust: New Issues, Questions, and Insights,
NERA Senior Vice President Dr. Sumanth Addanki demystifies a paradox
that, if left unexplained, could needlessly undermine the conclusions of
even a well-conceived econometric study of antitrust market definition.
The problem is this: economic theory says that a monopolist sets its
price according to a simple formula that describes a relationship
between the firm's profit margin and the firm's elasticity of demand.
What if your econometric study yields an estimate of the elasticity of
demand that is inconsistent with this formula? Is the theory wrong? Is
the firm mispricing its product? Is there a problem with the econometric
study? Or...is it none of the above? These questions are particularly
important because relevant market definition is frequently pivotal when
evaluating the competitive effect of a proposed merger or acquisition.