Related Links

• Diverging Trends in Market Concentration
• Are Markets Becoming Less Competitive?
• Are Markets Too Concentrated?

Transcript

Tim Sablik: My guest today is Nicholas Trachter, a senior economist and research advisor at the Richmond Fed. One of his research interests is how the organization of firms affects the overall economy, which is related to our topic of conversation today.

Nico, welcome to the show.

Nicholas Trachter: Thank you for inviting me. It's my pleasure to be here.

Sablik: You've done a lot of research on market concentration and market power, including some pieces that we worked on together. So, I'm excited to talk to you about your latest piece in this space.

You recently published an Economic Brief article titled, "Diverging Trends in Market Concentration." I wanted to start with something you discuss in the beginning of that piece. You note that many people conflate market concentration with market power. What do each of those terms mean, and why are they not necessarily the same thing?

Trachter: Market power is the ability of a firm to alter the price of a good or a product by tinkering with demand. On the other side, market concentration is just that — it's the concentration of activity among one firm or many firms.

Let me go back again now to market power. The ideal way to measure market power is to obtain the markup from charges — a markup is just the ratio of the price of the product to the marginal cost. So, when the markup is at zero, it says that the firm has no market power. When the markup is high, it means that the firm is able to obtain a surplus by selling its product to consumers.

Notice how this connects also with market concentration. If there's a lot of firms in the market, naturally, the firm has little power to have high prices related to the marginal cost. So, low markup [and] low market power is related to a low concentration [of firms]. On the flip side, high market power and the ability to have high markups links to few firms in the market.

Sablik: One thing that researchers and commentators have pointed out in recent years is that on a national level, market concentration has been rising. This fact tends to come up in the news whenever, say, two large firms merge to form an even bigger firm. Based on your research, is it right to think of all markets as national?

Trachter: Let me answer this question with two examples. Let's start with the example of car manufacturing. A car is very expensive. While the shipping costs of a car across the U.S. is kind of large, it's kind of small relative to the cost of the car. So, if you produce cars in Michigan and I produce cars in California, we still compete with each other because we can ship goods everywhere.

Now let's pick another example, another side of the spectrum. Let's pick the market for hot coffee. For the firm producing hot coffee in LA to sell its products in New York, he has to ship the hot coffee to New York. Now, relative to the cost of producing hot coffee, the transport costs of shipping goods from LA to New York is very high. So, naturally, I don't think it's the case that the hot coffee company in LA is competing with the hot coffee company in New York. You want to put your plants close to consumers, customers don't want to walk for miles to buy hot coffee.

So, the size of the market matters for this finding that the national concentration is going up. Probably for car manufacturing, the national market is the right measure for market concentration and people have found it is going up. But on the flip side, for hot coffee, probably the local market is the right definition of a market. And this is true for many industries. In particular, all retail and services are very local in nature. That's why firms have many, many stores close to customers.

Sablik: In your recent Economic Brief, you tried to measure concentration in local markets. What did you find?

Trachter: First of all, for manufacturing, we see a big rise in national concentration. But the big rise in national concentration is not consistent with what we see at the local level. At the local level, depending on which data source you use, you'll find a decrease in concentration or a slight increase in concentration. What you see for these industries is a divergence within the national and local measures.

The second point I want to make is that there's more activity in services and retail than in manufacturing. Once you add it all up, what you see is a divergence at the aggregate [level], meaning while you see an increase in national concentration for the whole economy, at the local level you'll see either a decrease or a slight increase.

Sablik: Do those findings change the way we should think about large firms and their impact on market competitiveness?

Trachter: I think so. The first thing to ask is, why did this happen? The key is that some of these big firms in retail had been growing exponentially. When they are growing, it's not that they're just adding more plants and more establishments at the same location. They are adding new plants in new places. What you see at the local level is enhanced competition.

By the way, it doesn't mean that we think that market power is not going up. For consumers, maybe what we see is an improvement in the prices that we pay. Why is this? Because the big firms are big for a reason. They're big because they're very productive, and because they're very productive they can charge lower prices.

Let me bring back the example of hot coffee that we used before. Imagine that we are in a small area where there's a local hot coffee producer. We may like it for many different reasons, but let me just think about prices — this is what we consumers care about. Now imagine that this national chain comes in. We don't see the local store dying. Typically, we see a local store become smaller. But now we have a national chain with a store and the local establishment also there but smaller. So, for us consumers, that's better because there's two stores that are competing locally and potentially prices are going down.

Sablik: How do you think your research contributes to the current debates around market power and consumer welfare?

Trachter: Market power appears in many different ways. It can appear in the pricing decisions of products — this is what affects us consumers directly. If you are very powerful, you can convince policymakers or others to put restrictions to new firms. You can also affect the creation of new firms. That's bad for consumers because new firms bring innovation. If you have the market power, you can also affect wages that are paid to workers.

But let me state that the typical margin that people think about, at least early on in the idea of market competition, is that firms are becoming very big. What we tend to point out is that, in that margin, we don't see a lot of evidence [which] suggests that consumers are being affected in a negative way by the big expansion of these big companies. We have to be very careful how we think about data, how to interpret the data to make the connection with market power.

Sablik: What are you hoping to research next on this topic?

Trachter: Among the big expansion of firms that we've seen in the data — one that everybody talks about — is in the banking industry. Since the '80s, the number of banks has been decreasing, but the number of establishments has been increasing. So, we're working with my colleagues on understanding what is the driver of this big expansion and what are the implications for consumer welfare.

Sablik: Nico, thanks so much for coming on to talk with me today.

Trachter: Thank you, Tim. It was a pleasure.