Competition, Product Differentiation

8/13/2019 Competition, Product Differentiation

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Presenter :

Febri Rahadi 1007443


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Paper InfoBoard of Governors of the Federal ReserveSystem (U.S.) in its series Finance and

Economics Discussion Series with number2004-46.

Andrew Cohen (Federal Reserve Board ofGovernors) and Michael J. Mazzeo (KelloggSchool of Management NorthwesternUniversity, USA)

Keyword : Product Differentiation (One

Characteristic of Monopolistic Competition)


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The relationship between product quality andmarket concentration has long been ofinterest to both industrial organizationeconomists and regulators

particular concern is the potential for firmswith market power to reduce their productquality in order to save costs and maximize

their profits Relatively little research has examined the

effects of competition on nonprice outcomes


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A. Product Quality and Market Concentration Competition may provide incentives for a firm to

increase quality

Alternatively, quality could make markets more

concentrated Try to find evidence of a connection between fixed

investments in quality and local market structure byanalyzing branching activity in a cross-section ofrural banking markets


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B. Bank Branching- in order to operate, a bank must open at least

one branch while additional branches mayserve to overcome a firms capacity constraintor to expand its geographic coverage

- Examine how differences in institution typemay affect firms branching decisions

- Also measure product differentiation amongsingle and multimarket institutions as well asbanks and thrifts


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to understand the relationship between bankbranching decisions (our measure of product quality)and market structure :

Bi,m:number of branches that institution i has inmarket m,

Zmis : vector of market-level control variables, : vector of parameters to be estimated, the vector

Nm : indicates the number and institution types ofthe competitors firm i faces in its market, i,m : represents the unobservable component of the

firms branching decision


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Profit Function

Xm:vector of control variables for theprofit function

: vector of parameters, and

m :market-level profit unobservable


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Data on banks and their branch networks from1,763 non-MSA labor market areas (LMAs)

- Focus on smaller geographic markets

-

eliminated all urbanized areas (MSAs) andlarger rural areas (LMAs with more than100,000 residents)

Thrifts operating in each LMA and the number

of branches owned by each obtained from theOffice of Thrift Supervisions Branch OfficeSurvey


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Approximately 59%of the firm/marketcombinations insample operate onlya single branch

including all theactive firms inapproximately20% of the marketsin sample.


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Explanatory variables contained in each stage of the estimation arebased on Authors intuition regarding which factors contribute to entry andbranching, respectively.


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S d B hi R i


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Second-stage Branching Regressions

- Strong NegativeCorrelation

- Significantly bias the

uncorrected results


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Competition from traditional single-marketbanks and thrifts is associated with smallerbranching networks

Institutions (of all types) tend to have morebranches (higher quality) when they facemultimarket banks as their competitors

implication of recent deregulation and

suggests that submarketswithin retailbankingare very important for understandingcompetition in this industry.


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Failing to account for the endogeneity ofmarket structure would have led tosignificantly different conclusions

Within correlations between product qualityand market competition, the effects onconsumer welfare are ambiguous.

Competition, Product Differentiation

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