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On the Misuse of the Profits-Sales Ratio to Infer Monopoly Power

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  • Franklin M. Fisher

Abstract

The common use of the profits-sales ratio as a measure of the Lerner index of monopoly power is flawed, even with the assumption of constant returns, because of problems connected with the valuation of capital. The size of the error is related to the cost of capital, the growth rate of the firm, the depreciation method used, and, most important, the shape of the stream of benefits resulting from an investment. Examples show that the error can be quite large; further, the error is likely to be systematically related to the variables used in regression studies.

Suggested Citation

  • Franklin M. Fisher, 1987. "On the Misuse of the Profits-Sales Ratio to Infer Monopoly Power," RAND Journal of Economics, The RAND Corporation, vol. 18(3), pages 384-396, Autumn.
    • Handle: RePEc:rje:randje:v:18:y:1987:i:autumn:p:384-396
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    Cited by:

    1. Boone, J. & van Ours, J.C. & van der Wiel, H.P., 2007. "How (Not) to Measure Competition," Discussion Paper 2007-32, Tilburg University, Center for Economic Research.
    2. Madhav V. Rajan & Stefan Reichelstein, 2009. "Depreciation Rules and the Relation between Marginal and Historical Cost," Journal of Accounting Research, Wiley Blackwell, vol. 47(3), pages 823-865, June.
    3. Lawrence J. White, 2012. "Market Power: How Does it Arise? How is it Measured?," Working Papers 12-06, New York University, Leonard N. Stern School of Business, Department of Economics.
    4. Jonathan B. Baker, 2003. "The Case for Antitrust Enforcement," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 27-50, Fall.
    5. Richard Frank & Raymond Hartman & Benjamin Sommers, 2007. "An Analysis of Price Discrimination in Brand Name Drug Wholesaling," International Journal of the Economics of Business, Taylor & Francis Journals, vol. 14(3), pages 299-315.
    6. Prageeth Roshan Weerathunga & Chen Xiaofang & Manoj Samarathunga, 2019. "Firm-specific and Contextual Determinants of Sri Lankan Corporate Hotel Performance," International Journal of Economics and Financial Issues, Econjournals, vol. 9(3), pages 213-224.
    7. Pittman, Russell, 2017. "Three Economist’s Tools for Antitrust Analysis: A Non-Technical Introduction," MPRA Paper 76201, University Library of Munich, Germany.
    8. Boone, J. & van Ours, J.C. & van der Wiel, H.P., 2007. "How (Not) to Measure Competition," Discussion Paper 2007-014, Tilburg University, Tilburg Law and Economic Center.
    9. P. R. Weerathunga & Cheng Xiaofang & W. H. M.S. Samarathunga & P. M. B. Jayathilake, 2020. "The Relative Effect of Growth of Economy, Industry Expansion, and Firm-Specific Factors on Corporate Hotel Performance in Sri Lanka," SAGE Open, , vol. 10(2), pages 21582440209, April.
    10. John Vernon, 2003. "The relationship between price regulation and pharmaceutical profit margins," Applied Economics Letters, Taylor & Francis Journals, vol. 10(8), pages 467-470.
    11. D. P. O'Brien, 1992. "Economists and Data," British Journal of Industrial Relations, London School of Economics, vol. 30(2), pages 253-285, June.
    12. Michael Salinger, 1990. "The Concentration-Margins Relationship Reconsidered," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1990 Micr), pages 287-335.
    13. Degl’Innocenti, Marta & Girardone, Claudia & Torluccio, Giuseppe, 2014. "Diversification, multimarket contacts and profits in the leasing industry," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 31(C), pages 231-252.
    14. John Vernon & Joseph Golec & J. Stevens, 2010. "Comparative Effectiveness Regulations and Pharmaceutical Innovation," PharmacoEconomics, Springer, vol. 28(10), pages 877-887, October.
    15. David S. Evans & Richard Schmalensee, 2013. "The Antitrust Analysis of Multi-Sided Platform Businesses," NBER Working Papers 18783, National Bureau of Economic Research, Inc.

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