The ready-to-eat cereal industry is characterized by high concentration margins,
large advertising to sales ratios, and numerous introductions of new products. Previous
researchers have concluded that the ready-to-eat cereal industry is a classic example
of an industry with nearly collusive pricing behavior and intense non-price competition.
This paper empirically examines this conclusion. In particular, I estimate price-cost
margins importantly I am able empirically to separate these margins into three parts:
(1) that which is due to product differentiation; (2) that which is due to multi-product
firm pricing; and (3) that due to potential price collusion. The results suggest
that given the demand for different brands of cereal, the first two effects explain
most of the observed price-cost markups. I conclude that prices in the industry are
consistent with non-collusive pricing behavior to maintain a portfolio of differentiated
products influence the perceived quality of these products, and it is these two factors
that lead to high price-cost margins.