Measuring competition; how are cost differentials mapped into profit differentials?

Using a simple oligopoly model and simulations we show that a given efficiency differential will be mapped into a bigger profit differential the more competitive the market is. This relation between relative profits and relative efficiency can be approximated by a linear regression equation in which the coefficient on relative efficiency measures the intensity of competition. With intensifying competition, this regression coefficient can be expected to increase in absolute value. We present firm-level panel data evidence in support of the empirical usefulness of the proposed indicator for a selection of Dutch four-digit industries over the period 1978-1992.