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Measuring market power in the supermarket industry: the case of the Seattle–Tacoma fluid milk market

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Abstract

In this paper, we estimate market power for supermarket chains by computing their price-cost margins for selling fluid milk. However, unlike most previous studies that assume Bertrand-Nash pricing conduct, we solve for pricing conduct, assuming a leader follower (Stackelberg) framework, and joint-profit maximization (monopoly) conduct, in addition to the widely used Bertrand-Nash pricing conduct. Price-cost margins are computed using estimates from a random coefficients multinomial logit demand model. Our results indicate that demand for milk at the supermarket chain level is elastic. Consumers, moreover, are more price sensitive to whole milk than to skim milk. In terms of pricing conduct, our results indicate that the Stacke1berg game, where, for instance, the Albertsons supermarket chain leads and Safeway follows, best fits the data at hand. This model implies that, on average, 23% of retail prices are appropriated by supermarket chains when selling fluid milk. Moreover, in the case of Albertsons whole milk, 76% of the marketing margin is explained by the cost of processing and distribution of fluid milk, and 24% is explained by the exercise of market power. Approximately 52% of the marketing margin is due to the exercise of market power in the case of skim milk sold by Safeway, while 48% is due to the cost of processing and distribution. [Econ Lit citations: L1, L2, L4, Q1]. © 2011 Wiley Periodicals, Inc.

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