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.