Market Power and Entry in the US Tire Dealer Industry - Economics Assignment Help

Assignment Task:

Task:

Based on Bresnhan and Reiss (1991), you are asked in this assignment to specify and estimate a static entry model with homogenous firms and complete info. In particular, as in Bresnhan and Reiss you will estimate entry thresholds and entry threshold ratios for tire dealers in the US.

The model you will estimate, however, will for simplification reasons be different from the model estimated in Bresnahan and Reiss (1991) in two aspects. First, whereas Bresnahan and Reiss use an additive specification of the error term, in this exercise you will —apply the multiplicative error specification. Second, Bresnahan and Reiss assume that the number of competitors affects both variables profits and fixed costs separately. You should use a specification where the number of competitors only affects the ratio of variable profits over fixed costs. Of course, these differences in specification will lead your results to differ from those of Bresnahan and Reiss for tire dealers.

You have a part of the data used in Bresnahan and Reiss on the number of tire dealers for a cross-section of 202 local markets in the US. The data are stored under the file name tiredata.dta. The variables are as follows:
tire: Number of tire dealers in town
uniq: Local market identifier
tpop: Town population in thousands
ngrw: Negative TPOP growth in thousands from 1970 - 1980
pgrw: Positive TPOP growth in thousands from 1970 - 1980
octy: Commuters out of the county in thousands
opop: Nearby population in thousands
landv: Value per acre of farmland and buildings
eld: 65 years and older as a proportion of the county population
pinc: Per capita income
lnhdd: Log of heating degree days
fracc: Fraction of land in farms

1. Discuss the number of tire dealers in town (variable tire).
2. Create a new variable (based on tire) that defines the number of tire dealers to be 5 whenever the number of tire dealers is above 5. Interpret this new variable. This will be your dependent variable in the subsequent analysis.
3. Define a variable that captures the total market size, S. Define S as the sum of town population (tpop), nearby population (opop), negative town population growth (ngrw), positive town population growth (pgrw) and commuters out of the county (octy).
4. Specify a model with the following independent variables: logarithm of total market size, 65 years and older as a proportion of the county population (eld), per capita income (pinc), log of heating degree days (lnhdd), fraction of land in farms (ffrac), value per acre of farmland and buildings (landv).
a. Provide summary statistics for these variables.
b. Provide a hypothesis of the expected sign of these variables
c. Estimate the model by OLS. Are the signs of the estimated coefficients the expected ones?
d. Use the ordered probit method to estimate (Stata command: oprobit) the model and briefly interpret. Indicate which output reflects the number of firm fixed effects α(n)*.

5. Calculate the entry thresholds and entry threshold ratios for a “representative market”. A representative market is a market with mean values for all independent variables. Provide an economic interpretation for your results.
6. Plot the ratios (S5/SN) by number of firms (i.e. Figure 4, page 996 of Bresnahan and Reiss, 1991). Provide an economic interpretation for your results.
7. Bresnahan and Reiss construct "isolated local markets".
a. What criteria do they use to select the isolated markets?
b. Bonus question: Why is the assumption of isolated local markets an important assumption for this model?

Part B. Merger Simulation [5]
1. Explain the steps of a merger simulation in the car market.
a. What do you estimate and what information do you need for that?
b. What do you simulate and what information do you need for that?
Note: The questions of Part B are based on the content and papers that will be covered in the lecture “Merger Simulation and Practical Matters”.

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