Working Paper: NBER ID: w12231
Authors: Chad Syverson
Abstract: In markets where spatial competition is important, many models predict that average prices are lower in denser markets (i.e., those with more producers per unit area). Homogeneous-producer models attribute this effect solely to lower optimal markups. However, when producers instead differ in their production costs, a second mechanism also acts to lower equilibrium prices: competition-driven selection on costs. Consumers' greater substitution possibilities in denser markets make it more difficult for high-cost firms to profitably operate, truncating the equilibrium cost (and price) distributions from above. This selection process can be empirically distinguished from the homogenous-producer case because it implies that not only do average prices fall as density rises, but that upper-bound prices and price dispersion should also decline as well. I find empirical support for this process using a rich set of price data from U.S. readymixed concrete plants. Features of the industry offer an arguably exogenous source of producer density variation with which to identify these effects. I also show that the findings do not simply result from lower factor prices in dense markets, but rather because dense-market producers have low costs because they are more efficient.
Keywords: Spatial competition; Heterogeneous producers; Price dispersion; Producer density; Empirical test
JEL Codes: L0; L1; D4; L6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher producer density (R32) | lower equilibrium prices (D41) |
| increased producer density (R32) | lower average prices (P22) |
| increased competition intensity (L13) | lower equilibrium prices (D41) |
| competition-driven selection eliminates high-cost producers (L11) | truncating the upper-bound price distribution (D39) |
| increased density (R23) | decline in upper-bound prices (P22) |
| increased density (R23) | decline in price dispersion (L11) |