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Prices, Spatial Competition, and Heterogeneous Producers: An Empirical Test

August 2004

Written by: Chad Syverson

Working Paper Number:

CES-04-16

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. ready-mixed 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 are low-cost because they are more efficient.

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demand, profitability, exogeneity, quantity, market, production, endogeneity, sale, cost, price, efficiency, heterogeneous, heterogeneity, competitiveness, metropolitan, pricing, profit, revenue, inflation, competitor, consumer, population, disparity

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Metropolitan Statistical Area, Census of Manufactures, Center for Economic Studies, Bureau of Economic Analysis, County Business Patterns, University of Chicago, Department of Economics, Social Security, Council of Economic Advisers

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