This paper compares two econometric methods that have been proposed for market definition: price correlations and residual demand curve estimation. Econometric theory is used to demonstrate that price correlations among firms will likely contain little or no information relevant to defining antitrust markets, under the assumption that a hypothetical cartel facing a downward sloping residual demand curve constitutes an antitrust market (defined according to the DOJ Guidelines). Hence price correlation analyses are likely to have little value for antitrust market definition. In terms of the literature on empirical techniques for market definition, this paper shows that if the econometric market definition algorithm based on residual demand curve estimation of Scheffman and Spiller (1985) is correct, then the econometric market definition algorithms based on price correlations of Stigler and Sherwin (1985) and Horowitz (1982) will not be valuable for antitrust enforcement. In the process of establishing these results, the paper clarifies the significance for antitrust market definition of reduced form price equations for single firms.
Baker, Jonathan , "Why Price Correlations Don't Define Antitrust Markets: On Econometric Algorithms for Market Definition" (1987). Working Papers. 56.