An Empirical Analysis of the Counterfactual: A Merger and Divestiture in the Australian Cigarette Industry

In this paper we empirically analyse two counterfactual situations facing an anti-trust authority following the merger of two of the largest international cigarette companies. First we estimate a nested logit model of demand for cigarettes. The implied elasticity of demand for smoking and implied marginal costs are both broadly consistent with the limited independent estimates available. We then use the model to simulate the proposed merger and the partial divestiture that was accepted by the Australian anti-trust authority. A comparison of the relative price changes predicted by the divestiture simulation with the actual post-divestiture price changes shows the model successfully anticipated the behaviour of the divested brands. This suggests structural econometric analysis using a nested logit may be usefully utilised by anti-trust authorities to assess the welfare implications of proposed mergers and partial divestitures. ∗Contact details: School of Economics and Finance, La Trobe University, VIC, 3086, Australia. +61 3 9479 1482 [email protected]. This paper builds on the work done by Vivienne Pham for her honours thesis at La Trobe University. The authors wish to thank her co-supervisor, Damien Eldridge, for his guidance during this period. Some of the work was done while David Prentice was a visitor at RSSS at the ANU and two visits at the University of Melbourne, and he is grateful for their hospitality and support. The authors would also like to thank Harry Clarke, Mick Coelli, Michelle Goeree, Philip McCalman, Harry Paarsch, Chris Skeels, Randal Watson, Jenny Williams, Nobu Yamashita and seminar participants at the U.S. Federal Trade Commission, La Trobe University and the University of Melbourne for their useful comments.