Modelling price competition under product differentiation and many firms (an application to the Spanish loans market)

This paper develops a framework to identity the pricing behaviour in a industry with a differentiated product and when there are many firms, and applies this framework to model competition among the more than 80 banks in the Spañish loans market during the period 1983-91. Using micropanel data on these banks, we compute (constrained) estimates of all own and cross demand elasticities and we use them to test competing equilibrium hypotheses (Bertrand, Cournot, collusion and somo non-symmetric partiel collusion equilibrium concepts). We find that the individual demands for (new) credits are highly elastic, that the interest rates seem to be effectively set with a margin over the anticipated rates of the interbank market (as predicted for the theoretical model), and that market power was clearly exercised during the period. A Vuong-type test for model selection points to a price coalition (collusion) among the banks that have a national dimension as the outcome that best fits the data. Welfare analysis indicates that the whole dead-weight loss due to market power could have reached, in the period under study, about 1 point of GDP