Objectives of the study Methods and data

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1.2 Objectives of the study

Based on the previous research questions, the aims of this study are: • To understand the relevant features of the Indonesian CPO industry in developing a framework for the theoretical and empirical model; • To explore various market power models and to determine the most suitable model for the Indonesian CPO industry; • To develop an empirical model to estimate the type of interaction and the degree of market power held by the dominant players, and to analyse possible factors that might explain the results; and • To use the estimation results to assess the effectiveness of current government policies and to propose some alternative policies that might prevent the abuse of market power and increase social welfare.

1.3 Methods and data

The study employs a dynamic duopoly model to measure the market power of dominant players in the Indonesian CPO industry. Specifically, an adjustment cost model with a linear quadratic specification is considered mostly appropriate to capture the important features of the industry. In particular, the long maturation period and an extended economic life in the CPO production pattern induce the substantial adjustment costs associated with changing the level of production. In this dynamic duopoly model, the reaction functions of the players are modelled through an adjustment system. In a static model, the slope of a reaction function is interpreted as conjectural variations, which show how a firm’s or group of firms’ Universitas Sumatera Utara 5 conjecture about its rivals’ reactions causes the firm to change its own actions. The conjectural variation values are also interpreted as the market power index. In contrast, in this dynamic model, the slope of a reaction function is the actual response rather than the conjecture of the response. The market power index is not directly inferred from but is calculated using the value of the slope. The index nests all possible behaviours, from perfectly competitive to perfectly collusive. In order to capture the specific characteristics of each duopolist, the symmetry assumption—that is common in the previous studies—is relaxed. With a symmetry assumption, the responses of both firms will be identical. Therefore, it can only show whether the firms interact cooperatively or non-cooperatively. Without the assumption of symmetry, the slope of a firm’s reaction function will show the firm-specific response. Hence, a more complex pattern of interdependence will be revealed Gollop and Roberts 1979. The relationship between the firms’ degrees of market power and the type of interaction between the firms provides insights into possible sources of the market power. The linear quadratic specification is useful as it allows the estimation of the market power index without using any cost data. Ideally, firm-level data would provide the best information about market power in the industry. However, firm-level data are insufficient, and therefore group data are used as an alternative.

1.4 Organisation of the study