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NEIO – New Empirical Industry Organization Models June 8, 2007

Posted by jyu in Qualifying.
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1. Incorporates more industry and firm specifics details in modeling demand, cost and competition as steps in analyzing the relationship between marketing mix and profits

2. Involves the development and estimation of structural models where firms’ choices are based on some kind of optimizing behavior (usually profit maximization)

3.  Have three basic ingredients (1) Demand specification (2) cost specification (3) specification for competitive interaction. 

–Regarding to competitive interaction, three approaches to model it: (1) the menu approach (bertrand equilibrium, Stackelberg leader-folower equilibrium, the collusive equilibrium) (2) the conjectural variation (CV) approach (incoporates conjectures about how competitors will react) and (3) the conduct and the weighted profits approach

One example:

Nevo (2001) – finds that the market power of  firms in the cereal market can be best explained by firms’ demand advantages through differentiated products targeted to different segments of the market than by anti-competitive conduct.

Advantages of NEIO Models:

1. Theory Testing: the structural approach provides an opportunity to test theories which the models are derived.

2. Ease of Interpretation: link to behavioral theory of firms

3. What-If Analysis: results are invariant to policy changes.  estimates can be used to perform what if analysis to predict the effects

4. Decomposing the determnants of market power and profitability:  specifically to consumer preference (demand structure), efficiency (cost advantages), and anti-competitive conduct (tacitly cooperative behavior)

Disadvantages:

1. Generalization: Not clear how the findings can be generalized

2. Simultaneity: Firms make their strategic marketing mix choices simultaneously.  Firm’s choice is a function of its rivals’ choice.  Firm’s choices affect demand and demand also affect the choices. Therefore, the realized demand and the firm’s strategic choices are simultanous. (can be accounted for by estimating the demand and choice equations as a system of simultaneous equations)

3. Endogeneity: In a structrual model, firm’s choices have to be treated as endogeneous.  Have to use instruments for these choice variables to account for the endogeneity.

— Researchers are advised to perform econometric tests to determine whether or not to treat varaibles as endogenous, and then determine if the endogeneity needs to be modeled as a separate process or whether it is enough to use instruments to account for endogeneity.

NEIO Challenges:

1. the lack of fully structural dynamic models of competition estimated in the NEIO literature

2. Issues of endogeneity, simultaneity and periodicity

3. the task of building and estimating a structural model is significantly harder under incomplete information (e.g. lack of information about demand and cost conditions) 

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