Critical Loss V. Diversion Analysis : Another Attempt at Consensus

In their response to our paper “Critical Loss vs. Diversion Analysis: Clearing up the Confusion,” Farrell and Shapiro provide a graphical illustration of our Retention Ratio adjustment to their suggested revision of critical loss analysis. In this rejoinder, we suggest that competition among a group of firms selling differentiated products may lead marginal customers to consider a set of differentiated products to be closely competitive at the equilibrium prices and thus, these consumers may substitute away from any narrow collection of products in response to a uniform SSNIP. In effect, the diversion ratios, central to the Farrell and Shapiro analysis, may not be stable when all the prices in the hypothetical market are increased simultaneously. Thus, empirical evidence on market responses should be considered to trump theoretical computations suggesting narrow markets. We conclude by responding to the more direct issues raised in the Farrell and Shapiro comment