Price-Cost Margins and Market Structure

Abstract

In this thesis, the relationship between some aspects of industrial market structure and industry price-cost margins or profit-revenue ratios is investigated. This is done mainly by building mathematical models based upon the tenet of profit maximisation. Empirical tests of the hypotheses developed are carried out using regression analysis on recent UK data. After an introductory chapter, the arguments are developed by successively taking structural features into account. Thus initially, problems involved in relating the structure of established firms in an industry to price-cost margins are considered. Then the possibilities and problems of potential entry into an industry are opened up. After that, the power of buyers from and sellers to the industry are brought into partial account. Additional potentially relevant structural factors receive a more cursory treatment before the analysis passes to empirical testing. At every stage, the relevant established literature is reviewed. It is found theoretically that the price-cost margin may be related to two main aspects of market structure, the "Herfindahl" index and a bilateral power index developed here. However, the commonly included "entry barrier variables need not, under reasonable assumptions, be considered relevant. The empirical results lend support to the theoretical conclusions regarding the Herfindahl and bilateral power indices. The contribution to knowledge in the subject area achieved herein is (hopefully) mainly in the rigorous development and application of models which have, in general, previously been rather vaguely based upon commonsense extensions of the fundamentals of economic theory. In fact, the thesis consists to a large extent in the belief that industrial economic problems often considered as having theoretically indeterminate solutions may be profitably examined and "solved" rigorously, with the judicious use of restrictive assumptions.