Katie Curry
Senior Economist, OFT
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Outline
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What is econometrics?
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Why is it useful?
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Example
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Defining the relevant market in a recent merger case
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What is econometrics?
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Statistical modelling of economic relationships
e.g. how consumers respond to price changes
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A commonly used technique is called regression analysis
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Regression analysis uses actual data to assess how one variable of interest (e.g. quantity consumed) is related to possible explanatory factors (e.g. price)
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What is econometrics? ctd.
● Allows for the fact we don’t have data on all possible influences by including an error term
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Use data to estimate equation of the form:
Y = a + bX + e
Error term.
Variable trying to explain.
Average value of Y.
X is the explanatory factor. b measures the average increase in Y caused by an increase in X.
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What is econometrics? ctd.
Y a b
X
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Why use econometrics?
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It allows us to analyse a large amount of information in a systematic way
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Suppose we have data on the price of ice cream and the quantity of ice cream eaten and we are interested in how consumer demand responds to changes in price
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We could look at what happened to ice cream sales every time the price changed
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But if there are lots of observations this could take a long timeand if we only look at one or two instances our conclusions could be unrepresentative
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Regression analysis can handle millions of observations easily
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Why use econometrics? ctd.
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Can give more meaningful results than simple statistics
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We could look at the average price of ice cream and the average quantity eaten in a large dataset very easily
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Knowing that a 5% price increase leads to a 1% reduction in demand could be much more helpful than simply knowing the average level of each
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Why use econometrics? ctd.
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Controls for effect of more than one variable
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We could use our data to make a chart, showing how quantity is related to price
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However there may be many other factors affecting quantity demanded that obscure this relationship (e.g. more ice cream in the summer)
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Econometrics can control for these other factors, allowing us to focus on the relationship we are interested in
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Example of econometrics in practice
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Example of econometrics in practice
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Used to define relevant market in a merger
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Merging parties overlapped in manufacture and supply of specific types of soft cheese
(Brie, Camembert and goat’s cheese)
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Parties submitted that British cheese was in a separate market from French cheese so there was no overlap
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Econometrics results used for market definition
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Used an econometric model to estimate how demand for one cheese changes when its own price and the price of a potential substitute changes
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The elasticity estimates obtained in this way were used to conduct a critical loss analysis
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Critical loss analysis uses data on profit margins and elasticities to calculate whether a 5% price increase would be profitable
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Starts with narrowest market- if not profitable, then move to broader market
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Almost Ideal Demand System
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Useful way of estimating demand when there are many brands that can be grouped together in segments
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Assumes customers decide how much to spend on one segment (e.g. camembert) and then decide which brand to buy
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Demand for each brand can be estimated as a function of the prices of all of the brands in the same segment
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The ideal model
SOFT CHEESE
Brie
Somerset
French branded
French private label
Camembert
Somerset
French branded
French private label
Other soft cheeses
Goat ’s cheese
Mozzarella
Etc.
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What we actually did
SOFT CHEESE
Brie
(All types)
Camembert
Somerset
French branded
French private label
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Illustrative results
% change in demand for:
Somerset
Camembert
Following a 1% change in the price of:
French private-label
Camembert
French branded
Camembert
Brie
Somerset
Camembert
French private-label
Camembert
French branded
Camembert
Brie
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Questions?
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