Applied Competition and Market Analysis

HT 2020

Assignment 2

In this assignment, you will apply the concepts taught in the course estimate linear regression
models using the software STATA. In groups of 3-4, answer questions 1-5 below and submit
your assignment on Canvas. You are allowed to discuss the questions with your classmates,
but each group should submit an original report. The report should contain a cover sheet with
names of group participants, course title and date. You should also include a reference list
where necessary. Please consult the following writing guide for assistance:
http://writingguide.se/reference-management/writingreferences/

Please ensure that tables and figures are readable. That is, when copying tables and figures
from STATA, please ensure that the axis labels and chart titles are legible. Also, each table
and figure should be numbered and labeled, and their contents described in text. In a separate
file, submit your do-file.
This assignment is graded on the G-U scale, where G=50-100% and U=0-49%.
Deadline: January 11, 2021

Instructions
Read the paper Market structure and market performance in E-commerce. Your task is to use
the data provided to replicate the results of this study. Replicating research is perhaps the best
way to learn how to conduct your own research. A copy of the paper is available on Canvas.
Also, the file “variable description” contains a description of all variables in the dataset.

The paper examines the effect of competition on markups. To do this, the authors use two
main methods:

1. Ordinary least squares (OLS) – multiple regression.

2. Instrumental variables1. You are not required to replicate the instrumental variables
results.
Your task is to replicate the OLS results in the paper. That is, tables 3, 4 and 5 show results
using different methods and report these results in different columns. Your task is to replicate
the results in the columns labeled OLS.

Question 1 (5 points)
Your first task is theoretical. According to theory, what is the relationship between
markups and competition? Hint: use Cournot model.

1
This is a method which accounts for correlation between the independent variable and the error term due to
omitted variables. Instrumental variables method also corrects for reverse causality between the independent and
dependent variables. Using this method allows the authors to address possible weaknesses in OLS estimates. In
the article, the authors refer to “biased estimates.” This means that the parameter estimates produced by OLS
may underestimate or overestimate the true effect.
Question 2 (15 points)
Estimate the following equation

markupit    1ageit   2 ageit2   3 numfirmsit   4 numfirmsit2  t   t   it

i = product, t = time period

Where markupit is a measure of markup over marginal cost for product I period t. Hackl et al.
(2014) use median markups and minimum markups as the dependent variable. The variables
age refers to the age of the product. Hackl et al. (2014) account for changes in markups over
the product life cycle by including the variable age2. The variable numfirms represents the
number of sellers and t is time fixed effects and  i is product fixed.
The authors estimate the relationship between markups and competition by using two
measures of markups: median markups and minimum markups.
a) Explain how Hackl et al (2014) calculated markups.
b) Replicate the OLS results in tables 3 and 4. [The authors state that they used fixed
effects. This is just another way of saying that they included dummy variables for time
and product. In the data provided, the variables prod_code1-prod_code70 and Apr_07
-Dec_08 represent product and month, respectively.] To replicate the results in tables 3
and 4, you estimate a linear regression model using the variables specified in equation
(1) while including time dummies and product dummies. Estimate one equation for
median markups and another for minimum markups. Do not report the parameter
estimates for the time and product dummies.
c) Interpret the results. What is the relationship between markups and market
concentration?

Question 3 (5 points)
a) Discuss why there are multiple prices for identical products in the market for digital
cameras. In other words, why don’t all consumers choose to buy the cheapest product?

Question 4 (10 points)

Your task is to replicate the OLS results in table 5. The authors estimate a model relating price
dispersion (measured as the coefficient of variation of prices) and competition.
a) Estimate the following equation:

dispersionit    1ageit   2 ageit2   3 numfirmsit   4 numfirmsit2  t   t   it

This is similar to equation (1) above, but the dependent variable is price dispersion rather
than markups. Start with defining price dispersion.
b) Interpret the results. What is the relationship between price dispersion and market
concentration?

Question 5 (5 points)
This is a rich dataset containing many variables. Based on the data available, can you
formulate a research question related to competition? Write down the equation you would like
to test. What signs do you expect your parameter estimates to have? Why? (Note: There is no
need to estimate the equation).