where ijt, mcijt indicate the time t profit and marginal cost of bank i located in federal state j.8 The Boone Indicator, given by the parameter jt, measures the effect of changes in marginal costs on profits. The specification in logs allows us to interpret the Boone Indicator as elasticity. As indicated by the subscript jt, we estimate the above regression separately for each federal state and for each year. The Boone indicator thus varies between federal states and over time.
The Boone indicator jt should generally be negative. Regardless of the degree of competition,
banks with higher marginal costs are expected to realize relatively lower profits.
Furthermore, changes in competition over time should result in appropriate changes in the Boone Indicator jt. This means that, according to the idea that the negative relationship between marginal costs and profit is steeper in more competitive banking markets, the Boone Indicator jt should take on higher values in absolute terms (i.e., more negative values) when competition increases.