The Concentration-Profitability Relationship: Is There a Critical Concentration Ratio?

A MAJOR concern of the body of economic analysis surrounding the theory of the firm is whether the pricing behavior of oligopolistic industries differs from that of competitive industries. Theory suggests that where small groups of sellers account for a substantial proportion of an industry's output, the recognition of mutual interdependence will result in the absence of price competition. Furthermore, the prices and profits are expected to be above the level that would obtain under competitive conditions. Empirical investigations of the relationship between seller concentration and profitability have produced results generally in accord with the theory. However, neither theory nor the empirical evidence provides a clear insight into the specific nature of the concentration-profitability association. The unanswered question is whether or not there is a 'threshold' level of concentration which separates groups of industries earning significantly different profit rates. The purpose of this study is to examine empirically whether a dichotomous functional form of the concentration-profitability association presents a better explanation of the underlying relationship than the continuous linear form: and, if it does, how concentration and profitability are related within the separated groups. The results suggest that there is a critical value for concentration and that there is no significant association between concentration and profit rates within high and low concentration groups.