The proper
geographic boundaries, as well as product boundaries, of a market
must be established before the construction of measures of market
structure. In the case of primary energy sources, the unevenness of
the distribution of energy reserves and the importance of
transportation costs raise the real possibility that competition
may occur within but not between regions. Professor Thomas Hogarty
has analyzed the geographic trading patterns of primary energy
sources. His report, presented in Appendix A, serves as the basis
for the following discussion.
There is
substantial theoretical literature on the question of geographic
markets but relatively little research has been conducted at the
empirical level. This may, in part, be due to the relatively high
degree of uncertainty in interpreting empirical results in this
area. Past attempts to delineate the geographic dimensions of a
market have often erred because of incorrect procedures. The proper
method is one that incorporates both supply and demand elements in
the analysis of trade patterns. The failure to include both
elements can lead to serious error.
Professors
Elzinga and Hogarty have developed a technique to define geographic
markets. Their procedure examines trade flows into and out of a
possible market area. To be a distinct geographic market, two
criteria must be satisfied simultaneously: (1) relatively small
amounts of the product flow into the region from outside; in
Hogarty's terminology, the little in from outside standard (LIFO),
and (2) relatively small amounts of the product flow out of the
region, the little out from inside standard (LOFI). It should be
emphasized that only by satisfying both criteria simultaneously can
a region be considered to be a distinct geographic market. In
interpreting the results of the analysis there is an element of
subjective judgement. This mainly arises because economic theory,
while able to indicate the principles by which geographic
boundaries should be established, cannot a priori indicate the
exact criterion that, if exceeded, warrants a conclusion that the
market is geographic rather than national in scope. In the study of
energy markets, 75 percent and 90 percent were adopted as weak and
strong standards respectively. In addition, an analysis of trading
flows at a given point in time is sensitive to the existing
relative prices. Changes in relative prices can lead to different
geographic boundaries.
The steps of
the procedure are as follows: