Scandinavian Working Papers in Economics

Working Papers,
University of Aarhus, Aarhus School of Business, Department of Economics

No 04-17: A Joint Estimation of Price-Cost Margins and Sunk Capital - Theory and Evidence from the European Electricity Industry

Werner Roeger and Frédéric Warzynski ()
Additional contact information
Werner Roeger: European Commission, Postal: European Commission
Frédéric Warzynski: Department of Economics, Aarhus School of Business, Postal: The Aarhus School of Business, Prismet, Silkeborgvej 2, DK 8000 Aarhus C, Denmark

Abstract: In this paper, we propose a new methodology to jointly estimate market power and the importance of sunk capital extending the work of Hall (1988) and Roeger (1995). We then apply this new technique to the European electricity industry using firm level data for the period 1994-1999, and analyze the impact of the 1996 European directive to liberalize electricity markets. We find that the average price cost margin has declined from 0.29 in 1994 to 0.22 in 1999. Moreover, the magnitude of the decline is linked to firm size: the largest firms have experienced a larger percentage fall. The variable cost parameter has increased from 0.36 in 1994 to 0.56 in 1999. The main reason of the change is the switch of the relationship between real labor productivity and the share of variable capital. Our results therefore document a more competitive electricity market and a more flexible and more efficient use of capital.

Keywords: market power; fixed capital; liberalization; electricity market

JEL-codes: D24; D40; L94

26 pages, December 10, 2004

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