How to measure competition in an economy in transition

Abstract

This paper attempts to find a robust method of measuring competition when firms' operational activities are subject to frictions. The first part theoretically tests the indicative quality of two competition measures, the price-cost margin (PCM) and the profit elasticity, in a model of monopolistic competition. The second part studies the empirical performance of the indices for a panel of Ukrainian manufacturing firms. This study offers a new approach to measuring profit elasticity that relies on structural estimation of a production function. The estimation methodology retrieves a productivity index that is adjusted to imperfect competition. The proposed method of measuring profit elasticity is found to be robust to frictions, but the PCM and traditional profit elasticity are biased, especially when the intensity of competition is low. Empirical findings show that competition exhibits a significantly positive correlation with aggregate productivity performance, while its impact on firm productivity is nonlinear.