Explaining the Concentration-Profitability Paradox
50 Pages Posted: 5 Dec 2016 Last revised: 12 Apr 2017
Date Written: December 1, 2016
This paper explains an empirical paradox which is often found, but generally ignored: a significant negative econometric relationship between profitability and market share concentration. The phenomenon can appear when there is a negative correlation between market share and costs - for example due to economies of scale. I show that concentration becomes an indicator for the cost competitiveness of direct rivals within an industry. Profitability of a given firm is undermined if price correlates positively with average industry costs (Classical natural prices) and frictions like sunk costs make an industry exit expensive for firms. This idea also explains the frequent findings of highly persistent profit rate differentials.
Keywords: Classical Political Economy, Competition theory, industrial organization, industry market share concentration, profitability
JEL Classification: B51, D24, D40, L11
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