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Data Analysis for

Competition Policy: an

Introduction toEconometrics

Katie Curry

Senior Economist, OFT

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Outline What is econometrics?

Why is it useful?

Example

- Defining the relevant market in a recent merger case

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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 toassess 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 dont have data on all

possible influences by including an error term

Use data to estimate equation of the form:

Y = a + bX + e

Variable tryingto 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.

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What is econometrics? ctd.

Y

X

a b

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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 quantityof ice cream eaten and we are interested in how consumerdemand responds to changes in price

- We could look at what happened to ice cream sales every timethe 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

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Why use econometrics? ctd. Can give more meaningful results than simple

statistics

- We could look at the average price of ice cream andthe average quantity eaten in a large dataset veryeasily

-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. Controls for effect of more than one variable

- We could use our data to make a chart, showing howquantity is related to price

- However there may be many other factors affectingquantity 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

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Example of econometrics in practice

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Example of econometrics in practice Used to define relevant market in a merger

Merging parties overlapped in manufactureand supply of specific types of soft cheese

(Brie, Camembert and goats cheese)

Parties submitted that British cheese was in a

separate market from French cheese so therewas no overlap

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Econometrics results used for market

definition Used an econometric model to estimate how demand

for one cheese changes when its own price and theprice of a potential substitute changes

The elasticity estimates obtained in this way wereused to conduct a critical loss analysis

Critical loss analysis uses data on profit margins andelasticities to calculate whether a 5% price increase

would be profitable

Starts with narrowest market- if not profitable, thenmove to broader market

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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) andthen decide which brand to buy

Demand for each brand can be estimated as afunction of the prices of all of the brands inthe same segment

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The ideal model

SOFT CHEESE

CamembertOther soft

cheeses

Somerset

French

branded

Brie

Goats cheese

Mozzarella

Etc.French

private

label

Somerset

French

brandedFrench

private

label

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What we actually did

SOFT CHEESE

CamembertBrie

(All types)

Somerset

French

brandedFrench

private

label

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Illustrative results

% change indemand for:

Following a 1% change in the price of:

SomersetCamembert

Frenchprivate-labelCamembert

Frenchbranded

CamembertBrie

SomersetCamembert

French private-labelCamembert

French brandedCamembert

Brie

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Questions?