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June 1985





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A merger in an industry with differentiated products increases the market power of the merging firms to the extent that their products are close substitutes and that other firms produce only more distant substitutes.' Such a merger makes the residual demand curve of each partner steeper, by shifting each in the direction of the industry demand curve. The extent of this increase in market power depends upon the own-elasticity of demand for each merging firm's product, as well as the cross-elasticity of demand for each with all other firms' products. As a result, evaluating the effect of a merger between two firms with n-2 other competitors would seem to require the estimation of at least n2 (n square) parameters (all of the price elasticities of demand), a formidable task.That extremely difficult estimation task is unnecessary, however. The necessary information is contained in the slopes of the two single-firm (residual) demand curves before the merger, and the extent to which the merged firm will face a steeper demand curve. For example, suppose a merger between two U.S. brewing firms, say Pabst and Anheuser-Busch, were proposed. It is not particularly important to determine whether it is competition from Miller or competition from Stroh (or from Heileman, or .. .) which puts the most effective brake on Anheuser-Busch's pricing. Only the total effect of these other firms and the particular effect of competition from Pabst are of interest.This paper proposes econometric procedures for estimating the demand system that merger partners will face, based only on pre-merger data. The key to the procedures is that the effects of all other firms in the industry are summed together. Formally, we start with a model of an n-firm product-differentiated industry. Manipulation of the model removes the prices and quantities of all but two firms. This reduces the dimensionality of the problem to manageable size; rather than an n-firm demand system, we estimate a two-firm residual demand system. In this way the technique extends our econometric method for evaluating single-firm demand elasticities in product-differentiated industries (Baker and Bresnahan [I984]).