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CUT-THROAT FRINGE COMPETITION IN AN EMERGING COUNTRY MARKET: TAX EVASION OR THE ABSENCE OF MARKET POWER?

Authors


  • *This paper won a Young Economists' Essay Award from the European Association for Research in Industrial Economics (EARIE) in 2007. It circulated previously under the title ‘Testing for Heterogeneous Business Practices across Firms in Developing Countries.’ I am greatly indebted to Ricardo Fort at the Coca-Cola Company for facilitating access to Nielsen's market data and McCann Erickson's advertising data. I also thank Isadora Nardy, Claudia Pessoa and Daniela Pisetta at the Coca-Cola Co. and, in particular, Bruno Gouvea at Nielsen. I am grateful to Alaor Dall'Antonia, Jr. and Maria Cristina Costa at the National Institute of Meteorology (INMET) for access to climatic data. I further thank Allan Collard-Wexler, Peter Davis, Tom Hubbard, Cristian Huse, Mike Mazzeo, Margaret Slade, Joel Slemrod, Scott Stern, John Sutton and Catherine Thomas, as well as the Editor and a referee, for comments. Financial support from CAPES and from the LSE, and the provision of research facilities by STICERD, are gratefully acknowledged. The usual disclaimer applies.

Abstract

Brazil's established soft-drink firms recently lost ground to multiple low-price entrants, with small-scale operations and minimal advertising. While incumbents attributed such undercutting to entrants' lower costs from non-compliance with the law, ‘generics’ counterargued that incumbents' high prices stemmed from unilateral market power rather than cost heterogeneity. By estimating a structural model, I can single-handedly explain established brands' high prices through low equilibrium price elasticities of demand. Tax evasion in the fringe, while plausible, appears to be offset by higher procurement costs or less efficient scale. More generally, a competitive informal sector can alleviate the allocative distortions in certain concentrated industries.

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