Industrial Economics Assignment 3

- Introduction:
The paper – “The Concentration-Margins Relationship Reconsidered”, by Michael
Salinger, discusses the cross-sectional relationship between the concentration of firms in
the marketplace and the price-cost margins.
Firstly – we must define what is meant by industrial concentration: It is the degree to
which production in an industry – or in the economy as a whole – is dominated by a few
large firms.
The author, Michael Salinger, emphasises that this relationship continues to affect
antitrust policies, and that the lack of research into this relationship has led to a
justification of a relaxed merger policy.

- Context of the Paper:

During the late 1960s, due to literature present at the time, there was an agreement
that concentration increased profitability and facilitated collusion. Thus, one of the
reports recommended the dissolution of companies with shares greater than 15 percent
of markets in which 4-firm concentration ratio exceeded 70 percent.
Even though it was never enacted, there were a lot of major monopolization suits in the
late 1960s and early 1970s – where the government alleged that firms had come to
dominate the markets through means other than providing better products. However, in
each, a serious counter-argument was made.
Demsetz provided evidence that it was only the large firms in concentrated markets that
had high returns. When both market share and concentration were included in
profitability regression – it was found that the coefficient of market share was positive
and statistically significant, and the coefficient of concentration was negative and
significant, but small.
Thus, the author covers the period of 1972-82 to show that high levels of concentration
were associated with cost and price increases from 1972 to 1982.

- Assumptions:
The paper focuses on cross-industry studies as opposed to individual industries –
because the author argues that individual industries fail to yield general insights.
The author also assumes in his calculations and methodology that potential entrants do
not alter the behaviour of the incumbents.
Lastly, during the calculations, the author assumes that estimates of demand elasticites
are not available.
 Industrial Economics Assignment 3
- Methodology:
The paper presents an equation for Price Cost Margin (PCM):

The reason for using the above regression by the author is that the correlation between
concentration and price-cost margins is a bit consistent with many of the oligopolistic
models – and hence supports the thought of modelling the markets as oligopolistic.
The evidence for would be stronger if B1 = 0, however Demsetz’ critique is that perfect
competition might imply B1 > 0 as well.
The Dependent variable: In early literature, the dependent variable was accounting
return of assets. It was later changed to Price-Cost margins, as they became popular.
Several recent papers, as mentioned by the author, have argued that the problems with
measuring economic depreciation are very severe, and that accounting measures of the
return on assets cannot be assumed to be in anyway correlated to the true return.
Hence, Salinger states that even if long-term profitability cannot be measured, price-cost
margins can be interpreted as measures of the short-term return on sales, which is turn
can be interpreted as the short-term Lerner Index.
Additional variables: In evaluating the equation:

Where the above equation holds true for a Cournot Equilibrium, with L being the market
Lerner index, H being the Herfindahl Index and n being the elasticity of demand.
Here, besides including concentration, we can include the demand elasticity for the
product itself – however, this approach was tried by Dennis Mueller who reported that
independent estimates of demand elasticities were uncorrelated with each other – and
hence, Salinger discards demand elasticity as a contributing factor, as mentioned in the
assumptions.

- Real Life Applications:

Salinger wants the policy of mergers to be stricter – despite the fact that increasing
concentration is generally associated with efficiency increases - citing that most
increases in concentration occur without mergers, so the efficient firms can increase
their market share without mergers. He also emphasises that the other methods of
increasing concentration are more important.
 Industrial Economics Assignment 3
However, Frank Lichtenberg’s study on the airline industry from 1970 – 1984 found that
mergers that increase concentration lead to cost and price reductions and to only a very
slight increases in profit margins.
It is also suggested by Lawrence White that the positive correlation in 1972 – 1982
period between the concentration in an industry to the change in prices, were caused by
the wage-price controls of the early 1970s, and that, the concentrated industries might
have been affected more than the non-concentrated ones, simply because they are
easier to control and manage.
Thus, in alignment with Sam Peltzman’s view, I believe that the policy for mergers
should be such that, mergers are allowed unless there are compelling reasons that the
merger might leaf to an anti-competitive outcome, and that, as Salinger suggests
throughout the paper, policy of mergers needs to be a bit stricter and not as lax as
during President Reagan’s era.

- Conclusion:

Salinger replicates Sam Peltzman’s result that productivity declines in industries

experiencing increasing producer concentration.