Goals of Oligopolistic Firms: An Empirical Test of Competing Hypotheses

Abstract

This paper reports the results of a test of three alternative hypotheses regarding the goals of firms in oligopolistic markets: profit maximization, constrained sales maximization, and entry prevention. A theoretical framework is developed which shows that an examination of firm price elasticities of demand provides evidence about firm motivation, since values less than one refute the profit-maximization and sales-maximization hypotheses, while providing support for Bain-type entry-prevention pricing. This analytical framework is supplemented by the derivation of a general relationship between market elasticity and firm elasticity of demand, which allows for an explicit treatment of the conjectural variations of firms. This relationship is then used to infer firm motivation from market elasticities, estimated for a group of 58 U.S. four-digit industries, over the 23-year period 1958 - 1980. The obtained market elasticities for 54 industries' were tested against the null hypothesis of a unitary elasticity. In all cases it was found that the price elasticity was not significantly greater than unity. Furthermore, 95% confidence intervals revealed that for 37 industries the price elasticity was smaller than unity, while for the remaining 17 industries the information from the constructed confidence intervals was inconclusive. Given the available empirical evidence, the changing pattern of competition, and the managerial motivation and behaviour in the modern oligopolistic world, one can plausibly argue that for most of the industries covered by this study individual-firm market shares have remained constant over the period under consideration. Assuming also consistent conjectures of rival firms [7], the results reported in this paper provide evidence against the profitmaximization and sales-maximization hypotheses, and in support of the entry-forestalling hypothesis. Our findings reinforce the results of earlier studies, which suggest that oligopolistic firms, recognizing the long-run costs of short-run greed, produce over the inelastic part of their demand curve in order to avoid the dangers of new entry and / or government