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New products and market competition.

Article Excerpt
Abstract

Using a novel data set on new product introductions in U.S. manufacturing, the paper studies the relationship between new product introductions and the intensity of market competition as it is measured by industry-specific price-cost margins. New product introductions intensify market competition and depress price-cost margins. These results draw significant empirical support from a sample of five U.S. manufacturing industries. A 10 percent increase in the number of new product introductions causes price-cost margins to drop by approximately 0.5 percent. Although price-cost margins appear procyclical with respect to fluctuations in industry sales, new products make price-cost margins less procyclical and therefore, the intensity of market competition more procyclical. (JEL E32, L16)

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Introduction

This study discusses the impact of new product introductions on the intensity of market competition, which is a neglected element in the literature. It presents a theoretical discussion of the idea and empirical evidence supporting it, using novel data on new product introductions that span 10 years and come from five U.S. 2-digit Standard Industrial Classification (SIC) manufacturing industries. It shows that new products intensify market competition, as it is measured by industry-specific price-cost margins (PCM). Also, more new products in the market make PCMs less procyclical (and therefore, the intensity of market competition more procyclical). Finally, the inclusion of new product introductions in the empirical estimations weakens the impact that other factors, such as import penetration and market demand, have on the intensity of market competition.

Market competition plays a pivotal role in companies' pricing decisions. However, measuring the intensity of market competition is not an easy task. Traditionally, researchers proxy the intensity of market competition with its implications on certain measurable economic variables. (1) The most common variable is the level of the average PCM in a given industry. Strong market competition forces companies to be aggressive in their pricing and therefore, to set low PCMs. Consequently, they identify the intensity of market competition with the level of the average price markup in a given industry.

Economists have pointed out various factors that influence the intensity of market competition in various industries. Domowitz, Hubbard, and Petersen [1988] emphasize industry concentration, while Field and Pagoulatos [1997] identify product differentiation, capital intensity, and import penetration as factors influencing market competition and PCMs.

Other researchers emphasize the dynamic fluctuations of PCMs over time. Domovitz, Hubbard, and Petersen [1986, 1988] found that PCMs are procyclical, while others support the idea of countercyclical PCMs (see Rotemberg and Saloner [1986], Bils [1989], Rotemberg and Woodford [1991], Warner and Barsky [1995], and finally Chevalier and Scharfstein [1996]).

This paper is organized as follows. In the next section, a brief theoretical discussion illustrates the relationship between new product introductions and PCMs. Then, the paper discusses the data used in the empirical analysis and includes empirical evidence in supporting the theoretical discussion. The final section concludes the paper.

Theoretical Motivation

The impact of new product introductions on the intensity of market competition--as proxied by the PCM--can be discussed in the context of two rather distinct families of models of monopolistic competition: those that are based on Chamberlin's model of monopolistic competition, as discussed by several authors (Dixit and Stiglitz [1977] or Perloff and Salop [1985]), and those that draw from Hotelling's model of spatial allocation, as discussed by Salop [1979].

Models of Monopolistic Competition

The Chamberlinian models of monopolistic competition assume many single-product firms in the...

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