58 1995, p. 390. Christiano 1990 demonstrated that results from both forms were
remarkably accurate.
In summary, the preceding dynamic models have successfully addressed the important features of dynamic behaviour that failed to be captured in the static models. In
particular, these models have explicitly modelled firms’ long run planning horizon with multi-period interactions, and show the process towards the consistent or steady state
equilibrium. These models also include state-space games models that would be needed when intertemporal links exist. Since, in general, market power appears to be a dynamic
phenomenon, the dynamic version is likely to be a more appropriate approach to modelling market power.
3.4 Concluding comments
Market power is understood to be a firm’s ability to maintain prices above marginal costs. Since marginal costs are usually difficult to determine, various models have been
developed to measure this power. These models correspond to the SCP and NEIO approaches. They may have either a monopolistic or oligopolistic market structure
framework. However, since monopolistic markets rarely exist in the real world, most empirical studies appear to have used the latter framework. The oligopolistic market
differs from the monopolistic one because players in the oligopolistic market have some interdependency. Each firm has some abilities to respond to another firm’s actions. The
early NEIO studies made an attempt to capture this interdependency with a model called the conjectural variations model. However, because of its static framework, this model
fails to capture the responses, which are clearly dynamic. Therefore, the use of the static model can be inappropriate and possibly misleading.
Game theory can be introduced to capture the interactions of two or more agents with conflicting objectives, thus providing a method for analysing the responses. Dynamic
models may be divided into the repeated-game and state-space game models. Each model is appropriate for different situations. The difference is in the intertemporal linkages,
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59 which exist in the state-space game cases but not in the repeated-game cases. These
dynamic models successfully reveal the dynamic behaviour that failed to be captured in a static framework. Therefore, in general, a dynamic model would be a more appropriate
approach to modelling market power.
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Chapter 4 Modelling Market Power in the Indonesian Palm Oil Industry
As demonstrated in the previous chapter, market power studies can be divided into static and dynamic models. Although static models may provide useful information about the
outcomes, in general, dynamic models have been found to be more realistic. Within a multi-period framework, they address the important features of dynamic behaviour that
are not captured by the static models. The dynamic models can be divided into repeated- game and state-space game models. In the repeated game, current actions affect only
current profits, while in the state space, current actions affect profits of the subsequent period as well as the current profits. In the presence of such an intertemporal link in the
palm oil industry, the state-space game model is likely to be a more appropriate model for this study.
The primary purpose of this chapter is to describe the analytical framework, assumptions and estimation techniques. In section 4.1, the theoretical framework of the state-space
model is presented. In section 4.2 the empirical model, namely the adjustment cost model with a linear quadratic specification, is explored. Then, the estimation method is
discussed in section 4.3. This comprises the discussion on the demand function, the adjustment system, Monte Carlo Numerical Integration and Bayesian inference. In
section 4.4, the various types of interaction that can result from the estimates are analysed. Section 4.5 brings the chapter to a conclusion.
4.1 Theoretical model
The following discussion of the state-space game model is drawn from Caputo 2005, Chow 1997 and Slade 1995. Consider an oligopolistic market with n firms or players,
whose objective is to maximise their discounted stream of profits over time. To achieve
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