Minimum Optimal Scale--Estimation and Analysis of Effects.
William Joseph Field · Deep Blue (University of Michigan) · 1980
Government policy can affect industry performance by altering industry structure. It is therefore important to underst and the relationship between them. This thesis investigates the effect of structure on two aspects of performance--the fraction of output produced by plants smaller than minimum optimal scale, and firm rates of return. The discussion begins with models of the firm's choice of plant size in industries with oligopolistic pricing coordination, and industries with high outbound shipping costs. From these models, the thesis draws inferences about the effect of industry structure on the fraction of output produced in plants of less than minimum optimal scale. These expectations are tested empirically using engineering-study estimates of plant minimum optimal scale. The effect of key structural variables is estimated using multivariate regression analysis of observations on a sample of 30 important manufacturing industries. Minimum optimal scale relative to the size of the industry, and outbound shipping costs had positive and statistically significant effects on the fraction of output produced by plants of less than minimum optimal scale. The four-firm concentration ratio and the industry rate of growth had negative effects. Since concentration is a structural variable which can be influenced by antitrust policy, the negative effect of concentration on the extent of small plants may imply the existence of an "antitrust dilemma," or tradeoff between allocative and technical efficiency. Further investigation revealed that this negative effect could be found only among highly concentrated industries, and was due to oligopolistic pricing considerations. The implication for government policy is that antitrust action need not cause losses in technical efficiency, if it is strong enough to break down oligopolistic pricing coordination. Two controversial questions in industrial organization are what relationship exists between industry structure and firm rates of return, and whether high rates of return are an indication of efficiency or market power. This thesis analyzes data on structural variables and firm rates of return (book net income as a fraction of stockholders' equity) for 86 large firms in 27 manufacturing industries during 1963 - 1967. A strong positive relationship exists between firm market share and rate of return. Using the size of minimum optimal scale of plant relative to the industry as a proxy for scale barriers to entry, the thesis found that the positive relationship between market share and rate of return is significantly stronger among firms in industries where scale barriers are large than among firms in industries where scale barriers are small. This result suggests that market power, at least in part, lies behind the market share-rate of return relationship.