Firm size inequality and market power

In this paper we reexamine the relationship between firm size inequality (FSI) and market power in light of modem oligopoly theory. Using a model with capacity constraints and endogenous conduct, we show that the market power-FSI relationship is more complex than the positive link traditionally predicted. We show that two separate effects are at work, leading to a U-shaped relationship between market power and FSI. We also show that prices should be more unstable in markets where FSI is high. We test these predictions on data for the U.S. airline industry and find results that support them. (C) 2000 Elsevier Science B.V. All rights reserved.