Relation of Profit Rate to Industry Concentration: American Manufacturing. 1936-1940 TORIo Joe s. bain The Quarterly Journal of Economics, VoL. 65, No. 3(Aug, 1951), 293-324 Stable url: http://links.jstor.org/sici?sici=0033-5533%028195108%02965%3a3%03c293%03aroprti%3e2.0.co%3b2-n The Quarterly Journal of Economics is currently published by The MIT Press Your use of the jStOR archive indicates your acceptance of JSTOR,'s Terms and Conditions of Use, available at http://www.jstor.org/about/terms.htmlJstOr'sTermsandConditionsofUseprovidesinpartthatunlessyou have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://wwwjstor.org/journals/mitpress.html Each copy of any part of a STOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission jStOR is an independent not-for-profit organization dedicated to creating and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support @ jstor. org http://wwwjstor.org Wed nov211:43:09200
THE QUARTERLY JOURNAL OF ECONOMICS Vol LXV August, 1951 No. 3 RELATION OF PROFIT RATE O INDUSTRY CONCENTRATION AMERICAN MANUFACTURING. 1936-1940 By JOE S.BAIN I. The concentration-profits hypothesis, 294.-II. Industry definition neasure of concentration, and selection of sample, 297.--III. Character and tions of profit data, 305 -IV. Calculation of accounting profit rates, 310 -V. Association of industry profit rates and concentration, 311.-VI. Asso- tion of firm profit rates and industry concentration, 317 -VII. associatie of profit rates with other determinants, 321 vil, Summary, 323 Students of industrial price behavior have recently shown much interest in the concept of workable competition and in the potential association between the workability of competition and the structure of the industry. I Their evident uncertainty about the nature of such a relationship suggests the need for detailed empirical studies which would formulate specific hypotheses on the relations of market structure to market performance and would then test such hypotheses with available evidence. In another place, I have advanced some hypotheses concerning such relationships, emphasizing those of seller concentration, buyer concentration, condition of entry of product differentiation to profits, selling costs, and relative effi- ciency of scale and capacity. This paper reports on the results of a statistical study of one of the relationships in this complex, as found in American manufacturing industries from 1936 through 1940 namely that of the size of profits or profit rates to the degree of seller concentration within industries 3 The Current Status of the Monopoly Problem in the United States, Harvard Law Review, June 1949, pp. 1265-85; M.A.Adelman Effective Competition and the Anti-Trust Laws, "ibid. September 1948, pp. ay 3. I am indebted to the Bureau of Business and Economic Research, Uni- versity of California, Berkeley, for extensive assistance in this study throughout the academic year 1949-50, and to Mr Allan Muir, who undertook substantiall all the work of statistical compilation and calculation and who contributed measurably to the development of statistical analyses. 293
294 QUARTERLY JOURNAL OF ECONOMICS I. THE CO Statement of the hypothesis to be tested involves an initial distinction among industries according to the degree of seller con- centration, recognizing(1) highly concentrated oligopolies, where a very few firms control a high proportion of industry output,(2)less ontrolled by a given number of firms is smaller but where oligopo- listic interdependence must still be presumed to exist, and (3)indus- tries of atomistic structure. The hypothesis in brief is that the average profit rate of firms in oligopolistic industries of a high concentration will tend to be significantly larger than that of firms in less concentrated oligopolies or in industries of atomistic structure. Firms in oligopolie of high seller concentration will tend to earn higher profit rates than all others. s This hypothesis is essentially developed from conven- tional price theory, and the manner of its development may be briefly traced a single firm monopolist or a group of oligopolists operating with effective express or tacit collusion should approach a conventional maximization solution and realize in long-run equilibrium the maxi- mum excess profit aggregate which is permitted by the relation of the industry demand curve to the costs of production and selling and by the conditions of entry 7 Sellers in industries of atomistic structure, or oligopolists who cannot reach or maintain fully effective collusion will not tend to maximize this excess profit aggregate, and 4. Before examining the hypothesis to be tested, let us note that the size of the profit rate for a firm or industry should not be regarded as a sole or an fallible index of the workability of competition. Clearly it is one of sever dimensions of market performance which must be interpreted as a complex in evaluating the workability of competition. Low or normal profits are ordinarily associated with certain model types of competitive equilibrium, and profits chronically much in excess of some normal rate with undesirable restriction of output and adverse income distribution effects. But the existence of a low profit te may be associated with adverse results on other levels(such as chronic excess apacity)and any profit performance must be read in the light of the rate echnical progress, the trend of de unable here to discover any net relation of concentration to the workability competition; we seek simply the relation of concentration to the profit rate, whatever its ultimate significane 5. The major distinction, it may be emphasized, is not between industried olies and all other industrie 6. The term excess profit is used here throughout to refer to a return luding imputed interest costs on equity capital, and no 7. The conventional maximization solution must be construed to ither one where marginal cost equals industry marginal revenue(as where blockaded or alternatively cannot be advantageously forestalled)or one
RELATION OF PROFIT RATE TO INDUSTI 295 with(1) identical entry conditions and(2)an identical industry demand and cost situation, will tend to sell at a lower price and receive a smaller profit. 8 In short, if we hold demand and cos conditions and entry conditions constant, monopoly or effectively allusive oligopoly tends to yield higher profit aggregates and prices in long-run equilibrium than competition or imperfectly-or non- collusive oligopoly Retaining suppositions(1)and(2)above, monopoly or effectively collusive oligopoly will also bring forth a higher excess profit rate on sales. This will be true even where cost and demand conditions are not identical, so long as the opportunity for aggregate profit relative to aggregate sales is the same. The excess profit rate on sales(after deducting all costs, including all paid and imputed interest)should average higher in long-run equilibrium among industries with monop- oly or effectively collusive oligopoly than among others, so far as on the average the relation of industry demand to cost and the conditions of entry are about the same This association should actually hold even in long-run equilibrium only on the average and not in each case. Similarity of demand-cost relations should be found only on the average, as should any similarity of entry conditions. When we leave the static model, the same association should tend to hold on the average through time, but a considerable dispersion of individual profit rates for particular inter- vals could be caused by difference in trends and fluctuations of demand, in the rate of innovation, and so forth. Thus individual industries in the more"competitive' category may have as high as or higher profit rates than individuals in the"monopoly 'category but on the assumption that all other influences on the profit rate f'average-out'' within groups, the group averages over time of excess profit rates on sales should differ in the manner indicated. 9 Average excess profit rates on sales should thus be higher with han without monopoly or effective oligopolistic collusion. This prediction evolves into one that there will be larger profit rates with high seller concentration than with moderate or low seller concentra- tion if we posit a systemati ation between the probability of ORO G s enough lower to forestall entry and thus to maximize the long-run pre American Economic Review, March 1949, pp. 448-64 to or below the competitive level 9. This averaging-out'' should also presumably apply to any effects of any other differences in market structure which may have an independent influence on profit rates
QUARTERLY JOURNAL OF ECONOMICS ffective collusion and the degree of seller concentration within an industry A tentative hypothesis is herewith advanced to that effect. Given this, we arrive at the hypothesis that there will be a systematic difference in average excess profit rates on sales between highly concentrated oligopolies and other industries. This difference should be found, strictly, even if there are on the average identical entry conditions in So far itry tends to be mo difficult in highly concentrated industries, as seems probable, there is a second reason for larger profit rates with higher concentration As the hypothesis is developed to this point, the predicted profit rate differences are explicitly differences in ratios of excess profit to sales. Because data on profit rates on equity are more readily available, let us inquire whether the predicted relationship should also hold for the ratios of profit to equity. The rate of excess profit sales may be expressed (non-operating costs and revenues being sales revenue minus contractual costs minus imputed interest Readily available profit-rate data are largely in the form of rates of return on investment or on equity before deducting imputed interest The relevant equity rate is sales revenue minus contractual cost stockholders'equ This may also be stated as ales revenue minus contractual costs minus imputed interest lus interest rate stockholders'equity These are of course all average rather than marginal rates. between firms or groups of firms, should the same relation hold among 1. That is, in highly concentrated oligopolistic industries, there will on the average be found more effective express or tacit collusion, and in oligopolistic industries of lower concentration as in industries of relativ structure, there will be found on the average less effective or more imperfec ollusion, more profit destructive rivalry of either an open or secret sort, and tht Bain, "Workable Competition in Oligopoly, "loc. cit, pp. 43-44 g. Cf.J. s 2. It is postulated throughout at this point that there is a theo ent of all magnitudes which appear in these ratios; the cha of such measurement al he possible aberrations in accounting measure discussed 06-10 belo appropriate cost 1. At the same appropriate cost valuation used in calculating imputed nterest