Firm size inequality and market power

In this paper we reexamine the relationship between firm size inequality (F SI) 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 pred icted. 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 o n data for the U.S. airline industry and find results that support them. (C ) 2000 Elsevier Science B.V. All rights reserved.