Specification and Testing the Profits-Concentration Relationship: Some Experiments for the UK

This paper discusses a simple methodological point which provides the basis of one explanation of the rather surprising set of results suggesting that concentration is not a significant determinant of industry profitability in the UK (see the survey by Hart and Clarke, 1979). The methodological point is the familiar one that, in fitting a regression, one is constraining the data to a specific functional form; thus, prior to hypothesis testing, one must ensure that the imposed form is an acceptable representation of the data. We shall apply this principle to the basic profits-concentration model which is almost always unquestioningly taken to be linear. In Section I below, we shall outline the basic profits-concentration relationship, showing that linearity is not an obviously appealing assumption to make. In Section II, we shall discuss estimation and testing procedures given uncertainty concerning the appropriate functional form; Section III contains some experiments on UK data (which show that the relationship between profits and concentration is positive but not linear); and Section IV contains our principal conclusions.