EE&MC simulation models can be characterised by three steps:
- The first step specifies and estimates a demand system.
- The second step makes an assumption about the equilibrium behaviour, typically a multi-product Bertrand-Nash equilibrium to compute the products current profit margins and their implied marginal costs.
- The third step usually assumes that marginal costs are constant, and predicts how prices will change after the merger, accounting for increased market power, cost efficiencies and perhaps remedies.
Demand and price elasticities are especially important for merger simulation models. In the case of merger, for example, the merged companies are assumed to have an incentive for price increases. A merger changes the elasticity of demand for the products of the merged company. As a consequence of the price increase the revenue reduces but this reduction can be partially compensated due to changes of demand elasticity. The impact on the demand elasticity depends on the substitutability of the products of the merged companies, as well as on the substitutability of competitive products. Therefore, the choice of a suitable simulation model is a first important step.
There are numerous methods of demand estimation and depending on the individual specifics and plausible assumptions of each case, the appropriate model is implemented.
- Linear and Log-linear models represent a simple method for estimation of demand. They only require an assumption on the variation of the cross-price elasticity along the demand curve.
- More applicable is the Almost Ideal Demand System (AIDS) Model. One benefit is the simple estimation of relevant parameters since we deal with an aggregate demand model.
- Another method provides the Proportionally-Calibrated Almost Ideal Demand System (PCAIDS) Model.
- If discrete choice models are needed the Nested logit model provides a high degree of flexibility.
- Conjoint analysis could be used to implement price forecasts
When estimating demand systems with the aim of retrieving elasticities and predicting price increases, one must be confident that the specification and data used are both adequate.
EE&MC experts are up to date with all modern demand elasticity estimation techniques and have extensive experience in this field of competition economics.