2 . Costs , demand , and imperfect competition as determinants of plant - level output prices

For approximately the last forty years industrial organization economists have undertaken empirical studies to determine if an increase in the number of producers results in more competitive market outcomes. In recent years a number of empirical studies, many under the inspiration and guidance of Leonard Weiss, have focused directly on the relationship between the price of output in a market and the number or size distribution of competitors. The main finding of this literature is clearly stated by Schmalensee (1989, p.988); "In cross-section comparisons involving markets in the same industry, seller concentration is positively related to the level of price."1 The methodology used in these price-concentration studies differs from that used in the earlier profits-concentration literature. In particular, each study generally focuses on a specific industry and uses observations from either different time periods or different geographic markets. Because they do not rely on across-industry differences in market structure to identify competitive effects, their inferences about competition are less likely to be biased by the across-industry differences in technology that are difficult to fully control for. Direct studies of output prices also avoid the substantial problems of accurately measuring economic profit.2 When examining the relationship between price and market structure it is important to control for variation in production cost across observations. In the majority of studies an observation is a local geographic market, often a city or SMSA, and the price and cost variables are constructed as an average for the market.3 What is lost in this type of data is any information on the extent of cost or output price heterogeneity among the producers in the market.4 However, the presence of within-market producer heterogeneity can affect the observed relationship between the average output price and market structure. For example, if all firms produce a homogeneous output under conditions of decreasing returns to scale, but differ in their factor prices or efficiency levels, then market price is determined by the costs of the least efficient firm. In contrast, the distribution of output will be skewed toward