Concentration and Profitability in a Small Open Economy

Abstract

IN industrial organization, it is commonly accepted that concentration ratios are useful indices of market power and that a positive relationship exists between these indices and profitability. Contrary to what is sometimes argued,1 theoretical bases can be found to support these views. For example, in his 'theory of oligopoly', G. Stigler [I6] has shown that the effectiveness of collusion leading to joint profit maximization strategies is increased by fewness of sellers and disparity of relative seller size. T. Saving [15] has established within the confines of the static price leadership model, that concentration ratios expressed by the share of the k largest firms can be related to the Lerner measure of the degree of monopoly. More recently, D. Encaoua and A. Jacquemin [i], have derived equilibrium relations between measures of concentration and aggregated Lerner indices for a whole set of static and dynamic, co-operative and non-co-operative, oligopoly models. However these studies have also demonstrated that concentration ratios are not the whole story of monopoly power and that only a refined analysis incorporating the various aspects of market structure and behavior allows an appraisal of the existence of the degree of monopoly. One aspect which is crucial for an open economy is the role of international trade.2 By overlooking it, numerous studies have not only used inappropriate variables to detect the existence or the effect of monopoly power, but have neglected the theoretical implications of the role of international factors for the behavioral relation between market structure and market performance.3 The purpose of this paper is to provide, for the Belgian manufacturing industry, a behavioral model allowing to test the validity of conventional concentration ratios as measures of domestic producers' market power and as determinants of the industry profit margin-viz. the Lerner index in case