1 Data Analysis for Competition Policy: an Introduction to Econometrics Katie Curry Senior Economist, OFT

2 Outline ● What is econometrics? ● Why is it useful? ● Example  Defining the relevant market in a recent merger case

3 What is econometrics? ● Statistical modelling of economic relationships  e.g. how consumers respond to price changes ● A commonly used technique is called regression analysis ● 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)

4 What is econometrics? ctd. ● Allows for the fact we don’t have data on all possible influences by including an error term ● Use data to estimate equation of the form: Y = a + bX + e 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. Error term.

5 What is econometrics? ctd. Y X a b

6 Why use econometrics? ● It allows us to analyse a large amount of information in a systematic way  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  We could look at what happened to ice cream sales every time the price changed  But if there are lots of observations this could take a long time- and if we only look at one or two instances our conclusions could be unrepresentative  Regression analysis can handle millions of observations easily

7 Why use econometrics? ctd. ● Can give more meaningful results than simple statistics  We could look at the average price of ice cream and the average quantity eaten in a large dataset very easily  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

8 Why use econometrics? ctd. ● Controls for effect of more than one variable  We could use our data to make a chart, showing how quantity is related to price  However there may be many other factors affecting quantity demanded that obscure this relationship (e.g. more ice cream in the summer)  Econometrics can control for these other factors, allowing us to focus on the relationship we are interested in

9 Example of econometrics in practice

10 Example of econometrics in practice ● Used to define relevant market in a merger ● Merging parties overlapped in manufacture and supply of specific types of soft cheese (Brie, Camembert and goat’s cheese) ● Parties submitted that British cheese was in a separate market from French cheese so there was no overlap

11 Econometrics results used for market definition ● Used an econometric model to estimate how demand for one cheese changes when its own price and the price of a potential substitute changes ● The elasticity estimates obtained in this way were used to conduct a critical loss analysis ● Critical loss analysis uses data on profit margins and elasticities to calculate whether a 5% price increase would be profitable ● Starts with narrowest market- if not profitable, then move to broader market

12 Almost Ideal Demand System ● Useful way of estimating demand when there are many brands that can be grouped together in segments ● Assumes customers decide how much to spend on one segment (e.g. camembert) and then decide which brand to buy ● Demand for each brand can be estimated as a function of the prices of all of the brands in the same segment

13 The ideal model

14 What we actually did

15 Illustrative results % change in demand for: Following a 1% change in the price of: Somerset Camembert French private-label Camembert French branded Camembert Brie Somerset Camembert French private-label Camembert French branded Camembert Brie

16 Questions?