This paper analyses the relationship between the foremost empirical competition indices and the actual intensity of interaction among firms under the presence of market frictions. The first part of the study compares the selected measures of competition within a model of monopolistic competition where the degree of substitutability among the product varieties is the determinant of the level of firm-to-firm interaction. The second part studies the empirical performance of the indices through a panel of manufacturing establishments operating in Ukraine during 2004-2007. Particular attention is devoted on the method of profit elasticity. However, this paper deviates from the literature by developing an alternative approach to
measure profit elasticity that relies on the structural estimation of the industry production functions. The estimation methodology takes into account of the unobservable prices at the firm level by introducing the demand side, and retrieves elasticity of substitution estimates jointly with TFP. The findings imply that the empirical price-cost margin and the traditional profit elasticity fail to indicate the true level of competition, especially when the intensity of interaction among firms is relatively low. However, the proposed method provides a robust measure that also exhibits significantly positive correlation with the estimated TFP.