Market Power, Economic Profitability and Productivity Growth Measurement: An Integrated Structural Approach

The purpose of this paper is to treat scale economies, profit-maximizing markups, economic profitability, capacity utilization and productivity growth within an integrated structural model, and to assess their interactions empirically using annual two-digit U.S. manufacturing data. Attention is focused on error biases in measuring productivity using traditional accounting procedures. An important conjecture by Robert Hall, that the coexistence of normal economic profits and positive markups of price over marginal cost imply the existence of substantial scale economies and excess capacity, is then examined using this structure. The empirical results suggest that markups in most U.S. manufacturing firms have increased over time, and tend to the countercyclical. However, procyclical capacity utilization and scale economies tend to offset the short run profit potential from markup behavior. As a result, on average economic profits are normal, but declining profitability is prevalent in most industries since the early 1970s. Also, although cost and revenue shares tend to be approximately equal, the error biases in standard productivity growth measures resulting from input fixity and scale economies are substantial, particularly over business cycles.