Review of Industrial Organization 12: 719–732, 1997.
1997 Kluwer Academic Publishers. Printed in the Netherlands.
Optimal Concentration and Deadweight Losses in
Economics, University of New Brunswick, Fredericton, N.B., Canada E3B 5A3
Economics, Simon Fraser University Burnaby, B.C., Canada V5A 1S6
Abstract. When economies of scale are impontant, there may be too many ﬁrms in a market to
effectively exploit these scale economies. Although more ﬁrms imply reduced market power, this
may not offset the adverse impact of higher unit cost. We explore this trade-off by estimating for
107 Canadian industries optimal concentration, this being the concentration that maximizes, for
given ﬁrm conduct, producers and consumers’ surplus. We then calculate deadweight losses as the
difference between total surplus at optimal concentration and total surplus at current concentration
levels. Among the conclusions are that the majority of industries have concentration that is too low.
Key words: Economies of scale, market power, optimal concentration, deadweight loss, Canadian
A recurring theme in Canadian industrial organization has been that the small
Canadian market produces industries with too many ﬁrms to exhaust economies of
More recently the possibility that industries can exhibit excessive entry has
been formally analyzed by, among others, von Weizsacker (1980), Perry (1984)
and Mankiw and Whinston (1986). In these models entry reduces average ﬁrm size
and so thwarts the exploitation of economies of scale. Although more ﬁrms imply
reduced market power, this may not offset the adverse effect of higher unit cost.
One solution is price regulation of a monopolist or, depending on economies of
scale relative to market size, price regulation of a small numbers natural oligopoly.
However because ﬁrms have incentives to avoid regulation and information is
impacted, even the best-intentioned price regulation is difﬁcult. Therefore a pre-
ferred direction may be to regulate structure. This leads naturally to the idea of
optimal industry concentration which, for given ﬁrm conduct, maximizes industry
welfare (the sum of producers and consumers’ surplus) by trading off economies
of scale and market power effects.
See Eastman and Stykolt (1967), Scherer et al. (1975), Gorecki (1976), Gupta (1979), Caves et
al. (1980) and Cox and Harris (1984).