The Concentration-Profitability Relationship In American Industry: A Varying Parameters Model

Abstract

The theoretical foundation upon which the structure-conduct-performance paradigm is built assumes that concentrated markets permit noncompetitive behavior on the part of the market participants permitting abnormal profits to accrue. Previous research examines this relationship in a variety of forms. In each case, no allowance is made for the relationship to change dependent upon the prevailing levels of economies of scale. This paper employs a varying-parameters model which relaxes the classes OLS assumption of constant coefficients for all sample observations. Instead, a factor-dependent, nonstocastic variable is incorporated which captures the manner in which concentration relates to profit margins based on measures of economies of scale The results show that while market concentration is associated with profit, the nature of the relationship varies with the prevailing scale economies. Scale economies prove effective based on the sample data in restraining noncompetitive behavior and limiting the ability of participating units to extract profits in excess of those witnessed in more competitive environments. This conclusion support the hypothesis that the use of scale measures as a varying parameter is suggested in any attempt to estimate the SCP relationship.