Measuring market power in the ready-to-eat cereal industry

The ready-to-eat cereal industry is characterized by high concentration, hi gh price-cost margins, large advertising-to-sales ratios, acid numerous int roductions of new products. Previous researchers have concluded that the re ady-to-eat cereal industry is a classic example of an industry with nearly collusive pricing behavior and intense nonprice competition. This paper emp irically examines this conclusion. In particular, I estimate price-cost mar gins, 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 pote ntial price collusion. The results suggest that given the demand for differ ent brands of cereal, the first two effects explain most of the observed pr ice-cost margins. I conclude that prices in the industry are consistent wit h noncollusive pricing behavior, despite the high price-cost margins. Leadi ng firms are able to maintain a portfolio of differentiated products and in fluence the perceived product quality. It is these two factors that lead to high price-cost margins.