Price markups and returns to scale in imperfect markets: Bulgaria and Hungary

Under perfect competition and constant returns to scale, firms producing homogeneous products choose output levels so that price equals marginal cost, which also equals average cost. However, any departure from these assumptions has important implications for the theoretical results derived and for the validity of the related empirical analysis. In particular, monopolistic firms charge a markup over marginal cost. We show that markups tend to be associated directly with the returns to scale of the employed production technology. We apply the theoretical model to a sample of manufacturing firms drawn from Bulgaria and Hungary. These two countries have taken different paths of transition to a market economy and are characterized by different sectoral structures of markups and returns to scale. Our quantitative results not only illustrate the effect of the returns to scale index on price markups and the relationship between the two indicators, but they also have implications for the longer-term consequences of institutional decisions and economic policy choices on firm performance. Journal of Comparative Economics 34 (1) (2006) 92-110.