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? 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.