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Category Archives: L13

The Upstream and Downstream Effects of Government Industrial Policy in the Rare Earth Elements Industry

By Charles Daniel  

The Chinese government has found considerable success in stimulating economic modernization through its industrial policy. The development of the rare earths industry, in both upstream and downstream markets, exemplifies this success. Rare earths are a group of metals whose natural properties make them critical for many pieces of modern technology. Upstream, Chinese raw rare earth producers extracted minimal output in 1985; by 2001 they accounted for more than 90 percent of global production. China stimulated this growth beginning in 1990 with implicit and explicit subsidies for rare earth producers, which enabled them to enter the market and produce at lower marginal costs than other world firms. These lower costs enabled Chinese producers to assume a market-leading position, and this paper explains the resulting developments in the upstream rare earth market through the Stackelberg model, which describes sequential quantity competition. In 2006, China introduced an additional policy of export quotas on rare earths, intended to benefit downstream Chinese firms. These firms depend on rare earths as inputs for the final goods (such as batteries and personal electronics) they produce. After the quota announcement, Chinese downstream firms benefitted from continued unrestricted access to rare earths, while non-Chinese downstream firms faced higher costs on the world market for rare earth inputs. This paper uses the Bertrand model, in which firms compete on prices, to examine the subsequent effects on these downstream markets. While Chinese rare earth producers were harmed by the export quotas, the combination of the subsidy and the export quotas enabled China to complete its economic goals: to first gain leverage in the rare earths industry, and to second transition its economy toward higher-value products and services.

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Advisors: Professor Alexander Pfaff, Professor Michelle Connolly | JEL Codes: L5, L52, L13

Competition from Incumbent Firms During Mergers: Estimating the Effect of Low-Cost Carriers on Post-Merger Prices

By Jonathan Gao

In an evaluation of a merger, the type of existing competitors in the market should play a role in constraining market power following the merger. In the airline industry, heterogeneity between low-cost carriers (LCCs) and legacy carriers suggest that the types of airline competitors could affect the price effects of a merger. This paper investigates the pro-competitive effects that existing, non-merging airline carriers have on prices when an airline merger occurs. Using data in the years around the 2008 merger between Delta and Northwest Airlines, the results show that average price levels of Delta and Northwest dropped after the merger, with larger price decreases on routes with LCC competitors. There is evidence that incumbent LCC competitors have a larger influence than legacy competitors in restricting post-merger prices and market power, confirming that the type of competitors matters in assessing the level of competition in a market. This paper also shows that much of the cost efficiencies from the merger were concentrated on routes with a hub of Delta or Northwest.

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Advisor: James Roberts | JEL Codes: L0, L11, L13 | Tagged: Airline Competition, Airline Merger, Market Structure

Empirical Evidence of Airline Merger Waves Based on A Selective Entry Model

By Peichun Wang

Ever since the Deregulation Act in 1978 in the U.S. airline industry, there have been series of major airline mergers and acquisitions, notably three major waves in the 1980’s, 1990’s, and late 2000’s. These mergers, especially the more recent multi-billion mergers (e.g. Delta- Northwest, United-Continental) have shown a trend of substantial market consolidation that inevitably worries consumers as well as the U.S. Department of Justice (DoJ). Most academic literature to date have tried to study mergers in a static setting where these mergers are assumed to be exogenous. However, the clear pattern of merger waves in the airline industry, as well as many other industries, suggests strong correlation between mergers. A few studies that attempted at a dynamic merger model remain theoretical due to computational barriers. In this paper, I found empirical evidence of merger waves by investigating the change of airline carriers’ incentive to merge after another merger between two other carriers. These results are based on a structural model of the U.S. airline industry, in which I estimate demand with a standard (for dierentiated product markets) discrete-choice nested logit model, but allow for selection on entrants’ costs and qualities, i.e. rms with lower costs and higher qualities would have been selected into the market before the merger, suggesting that post-merger entry is less likely than what non-selective entry models have predicted.

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Advisor: James Roberts | JEL Codes: L13, L25, L93 | Tagged: Airline, Merger Wave, Selective Entry

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