Evidence on Market Structure and Performance • 191

Interestingly, the actual average real prices over the period (1968–1986) to which GLV’s analysis pertains were $12.96 for Coca-Cola and $8.16 for Pepsi. The differentiated Bertrand model does an excellent job matching the actual pricing behavior of these two firms in the U.S. market. Note that both Coke and Pepsi’s equilibrium prices are well in excess of their marginal production costs. This illustrates that product differentiation softens price competition.

EVIDENCE ON MARKET STRUCTURE AND PERFORMANCE

The theories examined in the previous sections suggest that market structure should be related to the level of prices and profitability that prevail in a market. This is clearly true under Cournot competition, where price is directly related to the Herfindahl. It may also be true under Bertrand competition because each additional firm reduces the opportunities for differentiation. Many economists have tested whether the predicted link between structure and performance actually exists.

Price and Concentration

The relationship between price and concentration could be studied by comparing differences in price–cost margins and concentration levels across different industries. But price–cost margins may vary across industries for many reasons besides concentration, such as accounting practices, regulation, product differentiation, the nature of sales transactions, and the concentration of buyers.

For these reasons, most studies of concentration and price focus on specific industries.21 In these studies, researchers compare prices for the same products in geographically separate markets that have different numbers of competitors. By comparing the same products across distinct markets, researchers can be more confident that variations in price are due to variations in competition rather than to variations in accounting or other factors.

Leonard Weiss summarizes the results of price and concentration studies in more than 20 industries, including cement, railroad freight, supermarkets, and gasoline retailing. He finds that with few exceptions, prices tend to be higher in concentrated markets. For example, one study found that gasoline prices in local markets in which the top three gasoline retailers had a 60 percent market share were, on average, about 5 percent higher than in markets in which the top three retailers had a 50 percent market share.

Timothy Bresnahan and Peter Reiss used a novel methodology to study the relationship between concentration and prices. They asked, “How many firms must be in a market for price to approach competitive levels?”22 They examined locally provided services such as doctors, tire dealers, and plumbers. For each service, they calculated “entry thresholds,” defined as the minimum population necessary to support a given number of sellers. Let En denote the entry threshold for n sellers. For all services, they found that E2 was about four times E1. This could make sense only if prices are lower when there are two sellers than when there is one. When this happens, demand must more than double to make up for the intensified competition. They also found that E3 2 E2 . E2 2 E1, suggesting further intensification of price competition as the number of sellers increases from two to three. Finally, they found that E4 2 E3 5 E3 2 E2, suggesting that once there are three sellers in a market, price competition is as intense as it will get.