Showing papers on "Market power published in 2001"

Measuring Market Power in the Ready-to-Eat Cereal Industry

Abstract: The ready-to-eat cereal industry is characterized by high concentration, high price-cost margins, large advertising-to-sales ratios, and numerous introductions of new products. Previous researchers have concluded that the ready-to-eat cereal industry is a classic example of an industry with nearly collusive pricing behavior and intense nonprice competition. This paper empirically examines this conclusion. In particular, I estimate price-cost margins, but more importantly I am able empirically to separate these margins into three sources: (i) that which is due to product differentiation; (ii) that which is due to multi-product firm pricing; and (iii) that due to potential price collusion. The results suggest that given the demand for different brands of cereal, the first two effects explain most of the observed price-cost margins. I conclude that prices in the industry are consistent with noncollusive pricing behavior, despite the high price-cost margins. Leading firms are able to maintain a portfolio of differentiated products and influence the perceived product quality. It is these two factors that lead to high price-cost margins.

Quantifying the Benefits of New Products: The Case of the Minivan

Abstract: I develop a technique useful for obtaining more precise estimates of demand and supply curves when constrained to market-level data. It augments the estimation routine with data on the average characteristics of consumers that purchase different products. I apply the technique to the automobile market, estimating the economic effects of the minivan introduction. I show that standard approaches yield results that are meaningfully different from those obtained with my extension. I report benefits accruing to both minivan and non-minivan consumers. I complete the welfare picture by measuring the extent of first- mover advantage and of profit cannibalization both initially by the innovator and later by the imitators. My results support a simple economic story where large improvements in consumers' standard of living arise from competition as firms, ignoring the externalities they impose on one another, cannibalize each others profits by continually seeking new goods that give them some temporary market power.

Insiders versus Outsiders

Abstract: This article surveys the insider-outsider theory, which analyzes the behavior of economic agents in markets were some participants have more privileged positions than others. Incumbent workers (insiders) in the labor market enjoy more favorable employment opportunities than others (outsiders), on account of labor turnover costs (e.g. costs associated with hiring, training, firing, and insiders’ ability to punish underbidding outsiders). The theory provides an explanation of existence and persistence of unemployment, and helps account for the different employment experiences in Europe and the United States. The article also discusses policy implications and examines how the theory is related to unions and social norms. Assar Lindbeck is Professor of International Economics, Institute for International Economic Studies, University of Stockholm, and fellow at the Research Institute of Industrial Economics, IUI, both in Stockholm, Sweden. Dennis J. Snower is Professor of Economics, Birkbeck College, University of London, Research Fellow, Center for Economic Policy Research, both in London, United Kingdom; and Program Director at IZA, in Bonn, Germany. Their e-mail addresses are Assar Lindbeck and Dennis J. Snower 1 and , respectively. The insider-outsider theory examines the behavior of economic agents in markets were some participants have more privileged positions than others. In the labor market, incumbent workers, the “insiders,” often enjoy more favorable employment opportunities than the “outsiders.” The reason for this disparity is costs that firms incur when they replace insiders by outsiders – labor turnover costs for short. These can come in many forms, the most obvious ones being the costs of hiring, firing and firm-specific training, but they can also arise from insiders’ attempts to resist competition with outsiders by refusing to cooperate with or harassing outsiders who try to underbid the wages of incumbent workers. Since for reasons to be explained below these costs are borne, at least in part, by the employers, they give the insiders market power. The insiders use this power to push their wage above the market-clearing level, but firms do not try to replace them with outsiders since it would be costly to do so. The insider-outsider theory then proceeds to examine the implications of this behavior for employment and unemployment (Lindbeck and Snower, 1984, 1986). The theory was originally constructed as a microeconomic foundation of the existence of unemployment, hence an explanation for the absence of wage underbidding even though many unemployed workers would like to work for wages lower than existing insider wages, normalized for productivity differences. The theory, however, has also been applied empirically to more specific labor market issues, like the different employment experiences in Europe and the United States in Assar Lindbeck and Dennis J. Snower 2 recent decades. The insider-outsider distinction refers to a wide number of divides: employed versus unemployed workers, formalversus informal-sector employees, employees with high versus low seniority, unionized versus non-unionized workers, workers on permanent versus temporary contracts, skilled versus unskilled workers, the short-term versus the long-term unemployed, and so on. These distinctions also translate into social differences. In many developed countries nowadays growing attention is devoted to the phenomenon of “social exclusion”. Some individuals, families and other social groups are excluded from the mainstream networks of social relations within a society. They are typically unemployed or working at temporary, lowgrade, or dead-end jobs, and finance much of their consumption out of transfer payments (e.g. from social assistance programs, their parents’ incomes) the black market, or even criminal activities. They often live in the underclass neighborhoods of large cities, with meager social services, poor schooling, and scant police protection. These are the real “outsiders” in society, and their outsider position in the labor market is an important source of their social exclusion. These consequences are sometimes accentuated by rent control, which creates insiders and outsiders in the market for rented apartments as well; this group comprises individuals with poor networks, often as a result of their weak labor market position. In labor economics there are three main ways of explaining why some workers face less Assar Lindbeck and Dennis J. Snower 3 favorable employment conditions than others do. These correspond to the three general reasons why firms may be unwilling to replace their current employees by outsiders, even when the outsiders are willing to work at wages that would more than compensate the firm for insider-outsider productivity differences: First, legislation may keep the wage above its market-clearing level (the minimum-wage explanation). Second, firms may not accept the outsiders’ underbidding, since a fall in the wage may reduce productivity or increase the rate of labor turnover (the efficiency wage explanation). And third, it is not in the insiders’ interests to permit outsider underbidding and the insiders can impose their interests on their employers, since the insiders’ positions are protected by labor turnover costs (the insider-outsider theory explanation). The labor union and wage bargaining literature falls into the third category of explanation, since the insider-outsider theory provides a rationale for unions, explains what gives unions their clout and identifies sources of unions’ wage bargaining power. But the theory applies to far more than the labor market and the housing market. In general, whenever a buyer faces a cost of switching from its current supplier to another one, the current supplier thereby gains market power, which can be exploited by raising the price. For example, if product or credit market regulations make it costly for new firms to enter, then consumers will find it costly to abandon the existing suppliers in favor of new suppliers, and thereby the existing suppliers gain market power. Just as product markets become less than perfectly contestable when there are barriers to the entry of firms (Baumol, Panzar and Willig (1982)), so labor markets become less than perfectly contestable when there are labor turnover costs. Assar Lindbeck and Dennis J. Snower 4 This article is an idiosyncratic survey of the insider-outsider theory. Its overriding aim is not to provide a comprehensive summary of the relevant literature, but rather to describe the vision underlying the theory and to discuss salient contributions to the literature in the light of this vision. The rest of this article is divided into four sections. The first concerns the theory of how labor turnover costs influence wages, employment and unemployment. The second section deals with the insider-outsider theory in relation to two important economic institutions: unions and social norms. The third section confronts the relevant empirical evidence. The last section concludes by briefly presenting some policy implications.

Market power and efficiency in a computational electricity market with discriminatory double-auction pricing

Abstract: This study reports experimental market power and efficiency outcomes for a computational wholesale electricity market operating in the short run under systematically varied concentration and capacity conditions. The pricing of electricity is determined by means of a clearinghouse double auction with discriminatory midpoint pricing. Buyers and sellers use a modified Roth-Erev individual reinforcement learning algorithm (1995) to determine their price and quantity offers in each auction round. It is shown that high market efficiency is generally attained and that market microstructure is strongly predictive for the relative market power of buyers and sellers, independently of the values set for the reinforcement learning parameters. Results are briefly compared against results from an earlier study in which buyers and sellers instead engage in social mimicry learning via genetic algorithms.

Optimal bidding strategies and modeling of imperfect information among competitive generators

Abstract: The emerging electricity market behaves more like an oligopoly than a perfectly competitive market due to special features such as, a limited number of producers, large investment size (barrier to entry), transmission constraints, and transmission losses which discourage purchase from distant suppliers. This makes it practicable for only a few independent power suppliers to service a given geographic region and in this imperfect market each power supplier can increase its own profit through strategic bidding. The profit of each supplier is influenced to varying extents by differences in the degree of imperfection of knowledge of rival suppliers. A new framework to build bidding strategies for power suppliers in an electricity market is presented in this paper. It is assumed that each supplier bids a linear supply function, and that the system is dispatched to minimize customer payments. Each supplier chooses the coefficients in the linear supply function to maximize benefits, subject to expectations about how rival suppliers will bid. A stochastic optimization formulation is developed and two methods proposed for describing and solving this problem. A numerical example serves to illustrate the essential features of the approach and the results are used to investigate the potential market power.

Global electric power reform, privatization and liberalization of the electric power industry in developing countries

Abstract: In many developing countries, and in particular those in Asia, the Middle East, and Africa, reform of the power sector starts from a market structure that is dominated by a state-owned national power utility with a legally endowed monopoly and a vertically integrated supply chain encompassing power generation, transmission, distribution, and customer services. The rationale for this structure is minimization of the costs of coordination between these functions and of financing the development of power systems. The pre-reform structure in other countries, notably in South America, places distribution and customer services with local companies, separate from national companies that provide power generation and transmission. Power reforms are designed to introduce competition where feasible, which is in the upstream production and downstream supply functions of the industry structure, and to use economic regulation of the wholesale and retail power markets to promote competition and protect consumer interests. Regulation of the power market is essential, as shown by the experience of New Zealand, which tried an approach without the amount of regulation used elsewhere. Their approach was based on mandatory separation of generation, transmission, and distribution, using general competition laws to deal with both the terms of interconnection and conduct generally in unbundled power networks.

Plant- and Firm-Level Evidence on "New" Trade Theories

Abstract: By relaxing the assumption of perfect competition, the 'new' trade theory has generated a rich body of predictions concerning the effects of commercial policy on price-cost mark-ups, firm sizes, exports, productivity and profitability among domestic producers. This paper critically assesses the plant- and firm-level evidence on these linkages. Several robust findings are identified. First, mark-ups generally fall with import competition, but it is not clear whether this phenomenon reflect the elimination of market power or the creation of negative economic profits. Second, import-competing firms cut back their production levels when foreign competition intensifies, at least in the short run. This suggests that sunk entry or exit costs are important in most sectors. Third, trade rationalizes production in the sense that markets for the most efficient plants are expanded, but large import-competing firms tend to simultaneously contract. Fourth exposure to foreign competition often improves intra-plant efficiency. Fifth, firms that engage in international activities tend to be larger, more productive, and supply higher quality products. However the literature is mixed on whether international activities cause these characteristics or vice versa. Finally, the short-run and long-run effects of commercial policy on exports and market structure can be quite different. Both types of response depend upon initial conditions, sunk entry costs, and the extent of firm heterogeneity.

R&D Networks

Abstract: textMany markets are characterized by a high level of inter-firm collaboration in R&D activity. This paper develops a simple model of strategic networks which captures two distinctive features of such collaboration activity: bilateral agreements and non-exclusive relationships. We study the effects of collaborations on individual R&D effort, cost reduction, and market performance. We then examine the incentives of firms to form collaborative links and the architecture of strategically stable networks. Our analysis highlights the interaction between market competition and R&D network structure. We find that if firms are Cournot competitors then individual R&D effort is declining in the level of collaborative activity. However, cost reduction and social welfare are maximized under an intermediate level of collaboration. In some cases, firms can gain market power, and even induce exit of rival firms, by forming suitable collaboration agreements. Moreover, under certain circumstances, such asymmetric collaboration networks are also strategically stable. By contrast, if firms operate in independent markets then individual R&D effort is increasing in the level of collaborative activity. Cost reduction and social welfare are maximized under the complete network, which is also strategically stable.

Plant- and Firm-Level Evidence on

Abstract: By relaxing the assumption of perfect competition, the 'new' trade theory has generated a rich body of predictions concerning the effects of commercial policy on price-cost mark-ups, firm sizes, exports, productivity and profitability among domestic producers. This paper critically assesses the plant- and firm-level evidence on these linkages. Several robust findings are identified. First, mark-ups generally fall with import competition, but it is not clear whether this phenomenon reflect the elimination of market power or the creation of negative economic profits. Second, import-competing firms cut back their production levels when foreign competition intensifies, at least in the short run. This suggests that sunk entry or exit costs are important in most sectors. Third, trade rationalizes production in the sense that markets for the most efficient plants are expanded, but large import-competing firms tend to simultaneously contract. Fourth exposure to foreign competition often improves intra-plant efficiency. Fifth, firms that engage in international activities tend to be larger, more productive, and supply higher quality products. However the literature is mixed on whether international activities cause these characteristics or vice versa. Finally, the short-run and long-run effects of commercial policy on exports and market structure can be quite different. Both types of response depend upon initial conditions, sunk entry costs, and the extent of firm heterogeneity.

The Impact of Market Rules and Market Structure on the Price Determination Process in the England and Wales Electricity Market

Abstract: This paper argues that the market rules governing the operation of the England and Wales electricity market in combination with the structure of this market presents the two major generators National Power and PowerGen with opportunities to earn revenues substantially in excess of their costs of production for short periods of time. Generators competing to serve this market have two strategic weapons at their disposal: (1) the price bid for each generation set and (2) the capacity of each generation set made available to supply the market each half-hour period during the day. We argue that because of the rules governing the price determination process in this market, by the strategic use of capacity availability declarations, when conditions exogenous to the behavior of the two major generators favor it, these two generators are able to obtain prices for their output substantially in excess of their marginal costs of generation. The paper establishes these points in the following manner. First, we provide a description of the market structure and rules governing the operation of the England and Wales electricity market, emphasizing those aspects that are important to the success of the strategy we believe the two generators use to exercise market power. We then summarize the time series properties of the price of electricity emerging from this market structure and price-setting process. By analyzing four fiscal years of actual market prices, quantities and generator bids into the market, we provide various pieces of evidence in favor of the strategic use of the market rules by the two major participants. The paper closes with a discussion of the lessons that the England and Wales experience can provide for the design of competitive power markets in the US, particularly California, and other countries.

California's Electricity Crisis

Abstract: The paper examines the economic and regulatory factors that led to an explosion in wholesale power prices, supply shortages, and utility insolvencies in California's electricity sector from May 2000 to June 2001. The structure of California's restructured electricity sector and its early performance are discussed. The effects on wholesale market prices of rising natural gas prices, increasing demand, reduced power imports, rising pollution credit prices, and market power, beginning in the summer of 2000, are analysed, The regulatory responses leading to utility credit problems and supply shortages are identified. The effects of falling natural gas prices, reduced demand, state power-procurement initiatives, and price-mitigation programmes on prices beginning in June 2001 are discussed. A set of lessons learned from the California experience concludes the paper. Copyright 2001, Oxford University Press.

Market Power in Electricity Supply

Abstract: Restructuring of the power industry worldwide has brought the issue of market competitiveness to the forefront. While "vertical" market power has been limited by disaggregating generation and transmission, nondiscriminatory access to the transmission system by power suppliers, and the creation of the independent system operator (ISO), "horizontal" and localized market power still survives. In the last few years, the issue of a small number of generators exercising market power has received a great deal of attention, and much has been published on how to identify and mitigate such abuse by market management measures. This paper focuses on the analysis and mitigation of market power in electricity supply.

Competition and Enterprise Performance in Transition Economies: Evidence from a Cross-country Survey

Abstract: This paper uses a survey of 3,300 firms in 25 transition countries to shed light on the factors that influence restructuring by firms and their subsequent performance as measured by growth in sales and in sales per employee over a three-year period. We begin by surveying what a decade of transition has taught us about the factors that determine how firms respond to the new market environment. We go on to analyse the impact on performance of ownership, soft budget constraints, the general business environment and a range of measures of the intensity of competition as perceived by a firm. We find that competition has an important and non-monotonic effect on the growth of sales and of labour productivity: some degree of perceived market power is associated with higher sales growth, but competitive pressure is also important. A similar non-monotonic effect is found upon firms’ decisions to develop and improve their products, but market power has an unambiguously negative impact on purely defensive (cost-reducing) restructuring activity. New firms have grown very fast, but among old firms ownership per se has no significant relationship to performance (though state-owned firms have engaged in significantly less development of new products). Soft budget constraints have a broadly negative and the business environment a broadly positive impact on restructuring and performance.

A Quantitative Analysis of Pricing Behavior in California's Wholesale Electricity Market During Summer 2000

Abstract: We simulate competitive benchmark wholesale prices for electricity in California during the summer of 2000, taking account of changes in gas prices, demand, and imports during this time period. We also examine the impact of changes in the prices of NOx emissions permits on the competitive benchmark prices for electricity. The competitive benchmark prices are compared to actual prices. A significant fraction of the changes in wholesale electricity prices in California during Summer 2000 can be explained by these four factors. The impact of higher NOx permit prices, and their interaction with reduced imports into California, have a particularly large impact on competitive benchmark prices. However, during June, July and August a large unexplained difference between actual prices and competitive benchmark prices remains. We attribute this difference to supplier market power and related market imperfections. We then examine whether there is evidence of strategic behavior by suppliers during the highest priced hours during the summer. Evidence of supply withholding during these hours is identified.

Competition and Market Power in Option Demand Markets

Abstract: We call markets in which intermediaries sell networks of suppliers to consumers who are uncertain about their needs "option demand markets." In these markets, suppliers may grant the intermediaries discounts in order to be admitted to their networks. We derive a measure of each supplier's market power within the network; the measure is based on the additional ex ante expected utility consumers obtain from the supplier's inclusion. We empirically validate the WTP measure by considering managed care purchases of hospital services in the San Diego market. Finally, we present three applications, including an analysis of hospital mergers in San Diego.

Price transmission, market power, marketing chain, returns to scale, food industry

Abstract: Recent literature emphasises the role of market structure in determining the degree of price transmission along the marketing chain, the presumption being that if downstream markets are imperfectly competitive price transmission will be less than complete. However, empirical studies of market power often ignore the role of the underlying cost conditions. This paper shows that if an industry is characterised by non-constant marginal costs, there can be a significant impact on price transmission. Specifically, it is shown that the nature of the returns to scale that characterise the food industry cost function may either increase or decrease the degree of price transmission. Under certain conditions, price transmission may be greater in industries with increasing returns to scale than in markets characterised by perfect competition and constant returns to scale. Copyright 2001, Oxford University Press.

Marketing margins: Empirical analysis

Abstract: The marketing margin, characterized as some function of the difference between retail and farm price of a given farm product, is intended to measure the cost of providiing marketing services. The margin is influenced primarily by shifts in retail demand, farm supply, and marketing input prices. But other factors also can be important, including time lags in supply and demand, market power, risk, technical change, quality, and spatial considerations. Topics for future research include improved specifications for margins and demand and supply shifters, retail-to-farm price transmission of retail demand changes, and impacts of vertical integration and policy interventions.

Efficiency Effects of Bank Mergers and Acquisitions

Abstract: textNext to technological progress and deregulation, the introduction of the euro is widely considered to be an important catalyst for bank consolidation in Europe. In order to assess the public policy issues surrounding bank mergers, this paper analyzes the efficiency effects of 52 horizontal bank mergers over the period 1994-1998, i.e. the period immediately preceding the start of EMU. We find evidence of substantial unexploited scale economies and large X-inefficiencies in European banking. The dynamic merger analysis indicates that the cost efficiency of merging banks is positively affected by the merger, while the relative degree of profit efficiency improves only marginally. We do not find any evidence that merging banks are able to exercise greater market power in the deposit market. Hence, the bank M&As in this study appear to be socially beneficial.

Some Economic Aspects of Antitrust Analysis in Dynamically Competitive Industries

Abstract: Competition in many important industries centers on investment in intellectual property. Firms engage in dynamic, Schumpeterian competition for the market, through sequential winner-take-all races to produce drastic innovations, rather than through static price/output competition in the market. Sound antitrust economic analysis of such industries requires explicit consideration of dynamic competition. Most leading firms in these dynamically competitive industries have considerable short-run market power, for instance, but ignoring their vulnerability to drastic innovation may yield misleading conclusions. Similarly, conventional tests for predation cannot discriminate between practices that increase or decrease consumer welfare in winner-take-all industries. Finally, innovation in dynamically competitive industries often involves enhancing feature sets; there is no sound economic basis for treating such enhancements as per se illegal ties.

Transmission Constraints and Imperfect Markets for Power

Abstract: This article argues that, while most of the economic gains from the restructuring of the power industry will be achieved in electricity generation, trading and retailing, the transmission grid holds the keys to an important share of the economic value created by the process. Using a simple three-node network, this article shows that an increase in transmission capacity has two effects: (1) cheaper power can be used, and (2) competition among generators is increased. This carries three policy implications: first, policy makers can and should use transmission expansion to increase competition in generation. Second, generators will not necessarily finance nor advocate optimal transmission expansion: they may prefer to keep the rents derived from local market power, rather than gain better access to markets, even if they receive transmission payments corresponding to their investment, as suggested in parts of the United States. Finally, this work provides support for the vertical separation between generation and transmission, beyond the traditional foreclosure argument.

Market structure and entry: Where’s the beef?

Abstract: We study the effects of market structure on entry using data from the UK fast food (counter-service burger) industry over the years 1991-1995. Over this period, the market can be characterized as a duopoly. We find that market structure matters greatly: for both firms, rival presence increases the probability of entry. We control for market specific time-invariant unobservables and their correlation with existing outlets of both firms through a variety of methods. Such unobservables generally play a minor role. For both firms, variable profits per customer are increasing in the number of own outlets, and decreasing in the number of rival outlets. Structural form estimations show that the positive effect of rival presence on the probability of entry is due to firm learning: rival presence increases the estimate of the size of the market. The firms are differently affected by demand variables and have different fixed costs of entry. These results strongly suggest the presence of product differentiation, firm learning and market power.

Market and Cost Structure in the U.S. Beef Packing Industry: A Plant-Level Analysis

Abstract: A resurgence of consolidation in the U.S. meat packing industry in the past few decades has stimulated academic and policy debate. Issues raised include the role of cost economies in driving these patterns, and the effects on the agricultural sector (cattle producers) from market power. Here, plant level cost and revenue data for U.S. beef packing plants are used to estimate a cost-based model incorporating cattle- and output-market pricing behavior. The robust results indicate little market power exploitation in either the cattle input or beef output markets, and that any apparent evidence is counteracted by cost efficiencies such as utilization and scope economies. Copyright 2001, Oxford University Press.

European Competition Law and Economics: A Comparative Perspective

Abstract: The aim of this book is to explore the economic fundamentals of European competition law Even though most commentators would agree that competition policy is concerned with the economic consequences of market power, they would not all subscribe the view that curing the possible inefficiencies of market power is the sole aim of competition law In the USA, under influence of the Chicago School, the antitrust regulation focuses on economic goals and more specifically on allocation and production efficiency However, in European competition policy non-economic goals play a more important role European competition policy embraces a multitude of political goals The most prominent of these objectives, among others, is the achievement of market integration, which eventually may come at the expense of inefficiencies in the organisation of production and distribution In addition, European competition policy puts emphasis on consumer welfare, freedom of action and fairness and on the protection of small and medium sized companies Nevertheless, this book shows that an economic interpretation of the European competition rules remains possible; it is only required to broaden the traditional theorems of welfare economics with a full consideration of the consequences of efficiency savings for consumers, which obviously adds an additional layer of complexity to the analysis

Gaming and Price Spikes in Electric Power Markets

Abstract: Many challenging issues arise under the newly deregulated competitive electric power markets. Instead of centralized decision-making in a vertically integrated environment as in the past, decision-making is now decentralized and driven by market forces. Gaming and price spikes have been observed in almost every electricity market but explicit analysis of these phenomena is rare. In this paper, the authors study historical bidding behavior to see how power suppliers and demand service providers were actually bidding in the California day-ahead energy market. Based on their observations, they formulate a Prisoner's dilemma matrix game and introduce the notion of "opportunistic tacit collision" to explain strategic bidding behaviors in which suppliers withhold generation capacity from the market to drive up prices. This explanation is applicable with or without market power, transmission constraints, and insufficient supply, and is only enhanced by these factors. Their analysis is generally applicable to any uniform price electricity market in which there is significant insensitivity to price on the demand side.

Market Power Assessment and Mitigation in Hydrothermal Systems

Abstract: The objective of this paper is to investigate market power issues in bid-based hydrothermal scheduling. Initially, market power is simulated with a single-stage Nash-Cournot equilibrium model. Market power assessment for multiple stages is then carried through a stochastic dynamic programming scheme. The decision in each stage and state is the equilibrium of a multi-agent game. Thereafter, mitigation measures, specially bilateral contracts, are investigated. Case studies with data taken from the Brazilian system are presented and discussed.

Competition among banks: Good or bad?

Abstract: Introduction and summary In recent years we have witnessed a substantial convergence of research interest and the opening of a debate on the economic role of market competition in the banking industry. The need for such a debate may seem unjustified at first. The common wisdom would hold that restraining competitive forces should unequivocally produce welfare losses. Banks with monopoly power would exercise their ability to extract rents by charging higher loan interest rates to businesses and by paying a lower rate of return to depositors. Higher lending rates would distort entrepreneurial incentives toward the undertaking of excessively risky projects, thus weakening the stability of credit markets and increasing the likelihood of systemic failure. Higher lending rates would also limit firms' investment in research and development, thus slowing down the pace of technological innovation and productivity growth. Lower supply of loanable funds, associated with higher lending rates, should also be reflected in a slower process of capital accumulation and, therefore, in a lack of convergence to the highest levels of income per capita. These are some of the conventional effects that market power in the banking industry is commonly thought to generate. However, in more recent years, researchers have begun analyzing additional issues in the matter of bank competition, highlighting potentially negative aspects and so raising doubts regarding the overall beneficial welfare impact of bank competition on the economy. The research effort devoted to this issue has picked up noticeably, a sign that the time is ripe for an open debate regarding the costs and benefits of bank competition. [1] The policy implications associated with this issue, related to the regulation of the market structure of the banking industry, are especially relevant. In fact, banking market structure is a traditional policy variable for the regulator. Implicitly or explicitly motivated by the desire to restrain banks' ability to extract rents, policymakers would typically recommend measures aimed at fueling competition, promoting the liberalization of financial markets and removing barriers to entry (see, for example, Vittas, 1992). In light of the most recent regulatory changes affecting the U.S. financial industry, the policy relevance for U.S. regulators is more current than ever. In 1992 intrastate branching restrictions were relaxed, followed in 1994 by the passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act, which allows bank holding companies to acquire banks in any state and, as of June 1, 1997, to branch across state lines. Finally, 1999 saw the passage of the Financial Services Modernization (Gramm-Leach-Bliley) Act, allowing the operation of commercial banking, investment banking, and insurance underwriting within the same holding company. Such regulatory changes continue to have a significant impact on the market structure of the banking industry and on banks' competitive conduct. A deeper analysis of the economic role of bank competition should thus contribute to our understanding of the role of the regulator and the consequences of regulatory action and, therefore, support more effective policymaking. The goal of this article is to summarize some of the arguments that have recently emerged and to suggest some new lines of investigation. In the next section, I describe theoretical contributions that have identified both positive and negative effects of bank competition. Subsequently, I illustrate the results of existing empirical studies, which present mixed evidence regarding the economic role of bank competition. The main conclusion that seems to emerge from the review of the current literature is that the market structure of the banking industry and the related con duct of banking firms affect the economy in a much more complicated way than through the simple association: more market power equals higher lending rates and lower credit quantities. …