The Concentration-Profitability Relationship: Policy Implications and Some Empirical Evidence

• Author: Stephen A. Rhoades
• DOI: 10.1177/0003603X7301800212
• Published date: 01 June 1973
• Date: 01 June 1973
• Subject Matter: Article

THE CONCENTRATION.PRO,FITABIUTY

RELATIONSHIP:

POUCY

IMPLICATIONS

AND SOME EMPIRICAL EVIDENCE

by

STEPHEN

A.

RHOADES·

Since Adam Smith's landmark work on the wealth of na-

tions, economists generally have accepted the notion

that

the

number and size distribution of firms in an industry will in-

fluence the industry's profit performance. More recently,

Edward

Chamberlin established the proposition

that

product

differentiation creates

an

element of monopoly in an industry

quite

apart

from

that

created by a small number of sellers.'

Starting

from these basic postulates, students of industrial

organization have constructed atheory of industrial markets

which holds

that

the structure of an industry determines the

industry's profit performance. This theoretical framework

provided the reason

and

opportunity

for

large-scale statisti-

cal investigations of the structure-performance relationship.f

Almost all of these investigations have snpported the struc-

ture-performance hypothesis, and most have found

that

indus-

try

concentration, aproxy for monopoly power, is the single

most important determinant of an industry's profit perform-

anee."

• Staff economist, Division of Research and Statistics, Board of

Governors of The Federal Reserve System.

AUTHOR'S

NOTE:

This paper was written while the author was a

staff economist at the Federal Trade Commission. The views ex-

pressed in this paper do not necessarily reflect the views of the Board,

the Commission or their staffs.

1Edward Chamberlin, The Theory of Monopolistic Competition,

6th ed. (Cambridge:

Harvard

University Press, 1950), Chapter IV.

_ In addition to carefully articulating the structure-performance

relationship, Joe Bain made the first systematic statistical investigation

of the hypothesis. See Joe S. Bain, "Relationship of Profit Rate to

Industry Concentration: American ManUfacturing, 1936-1940,"

Quarterly Journal of Economics (August, 1951), pp,

293-324.

SA notable exception is George Stigler's 1963 study. Stigler's

analysis employed a large sample of IRS industries which were divided

333

334

THE

ANTITRUST

BULLETIN

There remains, however, an important disagreement, par-

ticularly from the standpoint of public policy, as to whether

the concentration-profitability relationship is continuous or

discontinuous. There

are

many who argue

that

the relation-

ship between concentration and profitability is essentially

linear and continuous.s On the other hand, there

are

those

who argue

that

there is a distinct break or discontinuity in the

concentration-profitability relationship. More specifically,

it

is argued

that

there is some critical level of industry concen-

tration, and

that

firms in industries above this critical level

earn

monopoly profits while firms in industries below this

level

earn

competitive or

near

competitive profits. Existing

empirical evidence indicates

that

the critical level of

industry

concentration occurs

at

about 70 percent for eight firms or 50

percent for four flrms."

into three groups according to whether they were concentrated, un-

concentrated or ambiguous. On the basis of correlation analysis and

tests for difference in group means, Stigler concluded

that

profit rates

in concentrated industries are not significantly different from profit

rates in unconcentrated industries. See George Stigler, Capital and

Rates of Return in Manufacturing Industries (Princeton: Princeton

University Press, 1963). However, in a later study, Stigler's findings

support the structure-performance hypothesis. See George Stigler,

CIA

Theory of Oligopoly," Journal of Political Economy (February, 1964),

pp.44.61.

4Among those who have presented evidence supporting the con-

tinuity thesis are Norman Collins and Lee Preston, Concentration

and Price-Cost Margins in Manufacturing Industries (Berkeley: Uni.

versity of California Press, 1968), esp. p. 107; Robert W. Kilpatrick,

"The Choice Among Alternative Measures of Industrial Concentra-

tion," Review of Economics and Statistics (May, 1967), pp. 258-270;

Stephen A. Rhoades, "Concentration, Barriers and Rates of Return:

A Note," Journal of Industrial Economics (November, 1970),

pp.82-

88; and George Stigler (1964), op. cit.

SAmong those who have presented evidence which supports the

discontinuity thesis are Joe S. Bain, "Relationship of Profit Rates to

Industry

Concentration: American Manufacturing, 1936.1940," op.

cit.; H. Michael Mann, "Seller Concentration, Barriers to

Entry,

and

Rates of Return in Thirty Industries, 1950-1960," Review of Eco-

nomies and Statistics (August, 1966), pp. 296-307;

and

David

Schwartzman, "The Effect of Monopoly on Price," Journal of Political

Economy (August, 1959), pp.

352-362.