9781118041581

Concentration and Prices

Concentration is an important factor affecting pricing and profitability within

markets.

Other things being equal, increases in concentration can be expected to be asso-

ciated with increased prices and profits.

One way to make this point is to appeal to the extreme cases of pure compe-

tition and pure monopoly. Under pure competition, market price equals aver-

age cost, leaving all firms zero economic profits (i.e., normal rates of return).

Low concentration leads to minimum prices and zero profits. Under a pure

monopoly, in contrast, a single dominant firm earns maximum excess profit

by optimally raising the market price. Given these polar results, it is natural to

hypothesize a positive relationship between an industry’s degree of monopoly

(as measured by concentration) and industry prices. For instance, the smaller

the number of firms that dominate a market (the tighter the oligopoly), the

greater is the likelihood that firms will avoid cutthroat competition and suc-

ceed in maintaining high prices. High prices may be a result of tacit collusion

among a small number of equally matched firms. But even without any form

of collusion, fewer competitors can lead to higher prices. The models of price

leadership and quantity competition (analyzed in the next section) make

exactly this point.

There is considerable evidence that increases in concentration promote

higher prices. The customary approach in this research is to focus on particu-

lar markets and collect data on price (the dependent variable) and costs,

demand conditions, and concentration (the explanatory variables). Price is

viewed in the functional form

where C denotes a measure of cost, D a measure of demand, and SC seller

concentration. Based on these data, regression techniques are used to esti-

mate this price relationship in the form of an equation. Of particular inter-

est is the separate influence of concentration on price, other things (costs

and demand) being equal. The positive association between concentration

and price has been confirmed for a wide variety of products, services, and

markets—from retail grocery chains to air travel on intercity routes; from

cement production to television advertising; from auctions of oil leases and

timber rights to interest rates offered by commercial banks. More generally, a

large-scale study of manufacturing (using five-digit product categories) for

the 1960s and 1970s shows that concentration has an important effect on

Pf(C, D, SC),

358 Chapter 9 Oligopoly

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