The Behaviour of Risk-Averse Firms in a Duopolistic Market

The study of the determinants of the behaviour and scale of business firms is one of the most pervasive and fascinating research topics in the field of industrial economics. As Schmalensee put it in a recent survey article (1988), it represents, nowadays as in the past, one of the main topical foci which define the discipline. Several studies, often supported by a large body of empirical research, have proposed different explanations of size inequality and seller concentration. Among these, as Tirole (1989) argues, the ones which stressed the link between basic market conditions, such as technology and consumer preferences (Scherer, 1980), and the scale of the firms, have played a crucial role in the development of both the theoretical and empirical literature. According to these studies, economies of scale (or scope) would be ‘the most obvious candidates’ to explain such empirical regularities as ‘the high rank correlations of manufacturing industries’ concentration levels between industrialised nations’ (Schmalensee, 1988, p. 653). However, as Tirole puts it (1989, pp. 20–1), it can be argued that this ‘technological view’ does not provide a satisfactory theory of firm size. In a decentralized market economy, with negligible transaction costs, firms could duplicate their activities, operating sub-divisions as quasi-firms, in order to overcome the limits to their size imposed by increasing average cost curves. On the other hand, firms could decide to exploit technological advantages ‘through contracting with separate entities’ (Tirole, p. 20).