IN recent years there have been notable advances in the methodology used in empirical studies of state and local public spending. The rather ad hoc econometric studies of the mid-1960s are being replaced by more carefully specified models, e.g., Barr and Davis (1966), Ohls and Wales (1972), Borcherding and Deacon (1972), and Bergstrom and Goodman (1973). Most of these efforts share the common feature that expenditures are viewed as responses to collectively exercised demands. While these studies have yielded insights, all have been partial equilibrium in nature and none has incorporated the possibility of substitution among public services in response to changes in relative costs. A goal of the present paper is to fill this gap by directly modeling and estimating such substitution effects in collective consumption. To accomplish this, it is convenient to view expenditure decisions in the public sector as analogous to consumer choices in the private sector, i.e., as if generated by utility maximization subject to a budget constraint. Quite aside from any advantages this approach holds for empirical analysis, this view of the public decision-making process has been highly attractive to theoretical researchers. Although the utility maximization paradigm has never been subjected to a direct empirical test, it has been employed to predict the effects of intergovernmental grants and spillovers across jurisdictions, and to examine other topics. A second aim of this analysis, therefore, is to provide empirical evidence on the tenability of this view of the local public sector.

T HERE has been much theoretical work done on models of information and search beginning with the work of Stigler (1961, 1962) but there has been little empirical investigation of the implications of these models. With the importance these models have attained in describing macroeconomic phenomena such as the Phillips curve, this empirical work is necessary to guide any potential methods designed to reduce the unemployment rate. This paper examines the time path of wage demands of the unemployed as a test of some of the implications of the search models. Most of the theoretical work has been devoted to analyzing the optimal behavior of individuals who must make choices on the basis of incomplete information and of the equilibrium behavior of markets whose participants behave according to particular search rules. For labor markets it follows that it is not necessarily optimal for an individual to accept the first job offered to him, and thus, the equilibrium position will be characterized by positive unemployment. The search strategy of an unemployed individual usually takes the following form. Search until a wage offer is received that is above some reservation wage, this reservation wage being determined by maximizing expected returns. Since search is a sequential process, the sequence of reservation wages completely describes the behavior of the agents.1 Furthermore, it is derived in most of the theoretical work that this sequence of reservation wages is either constant or monotonically declining. People who remain in the market are willing to accept successively lower wages as time passes.2 This seems to be a paradoxical result about learning, i.e., time always makes one pessimistic. The models in which this monotonicity property is generally derived, do not consider learning as part of the mechanism generating behavior, but for any consistent model of both search and turnover (implicit in the search theories of the Phillips curve) it is required that individuals revise upward their expectations of the wage distribution with the state of the economy. In an economy that is constantly changing, learning should be an important determinant of search. It is hypothesized that when one is permitted or required to learn about the wage distribution through sampling, it seems reasonable to expect that initially pessimistic individuals will revise their wage demands upward before sampling terminates. This paper will argue that the above hypothesis is correct and that the sequence of reservation wages is not monotonically declining. The first part of the paper will present a heuristic formulation of a search and learning model where it can be seen that the sequence of reservation wages depends on the initial expectations of an individual and on the particular sequence of information (including wage offers) that an individual obtains. Although the particular search rule analyzed is not derived from optimization, it should help develop the intuition necessary for believing that reservation wages can and do rise in the course of search. The formulation could be considered as the study of behavior characterized by bounded rationality, but it is mainly presented to motivate the empirical work. The empirical evidence presented supports the hypothesis that a monotonically declining sequence of reservation wages is not an accurate description of actual search behavior of unemployed individuals looking for jobs. The sequence of reservation wages depends heavily on the perceived and actual wage distribution.

THIS paper examines the effect of market on the rate of return of selected firms operating in different market environments. It will be shown that the effect of on profiltability depends on the degree of concentration and rate of growth in the industries in which the firm competes, and on the absolute size of the firm. One of the most important propositions of micro-economic theory is that under competitive conditions, rates of return tend toward equality. A casual look at the data will reveal that rates of return are not equal and that differences in rates of return often persist over time. Many studies have utilized industry concentration as a measure of market power and have analyzed the effect of concentration on industry profitability (a sizeable list may be found in Weiss (1971)). Three recent studies have looked at the effect of concentration on profitability using the firm as the unit of analysis (Federal Trade Commission (FTC), Hall and Weiss (1967), and Shepherd (1972)). Although data is not generally available for most firms, the FTC study does examine the effect of relative market share (market divided by the big four firm concentration ratio) on profitability in food manufacturing firms, while the Shepherd paper examines the effect of market for a sample of large, nondiversified firms. The more recent of the above studies emphasize additive multiple regression models. While these models attempt to control for the effects of some dimensions of market structure when focusing on the effect of a particular structure variable, they do not capture the interaction effects of structure variables on profitability. Two independent variables are said to interact if the effect of one independent variable on the dependent variable depends on the level of the other independent variable. Interaction effects may be analyzed in the following three ways (1) specifying an interaction model, (2) including interaction variables in an additive model, or (3) by estimating the parameters of an additive model for subgroups of the total sample. A version of the third method is employed in this study and will be discussed in section I. To illustrate this subgrouping method, suppose we divide our sample into two subsamples (A) firms in highly concentrated industries and (B) firms in lowly concentrated industries. As will be explained below, we expect that the slope coefficient from a regression of profitability on in the high concentration subgroup will be much higher and more significant than the slope coefficient from the low concentration subsample. The primary goal of this paper is to develop and test a theory of the effect of firm on profitability under various competitive situations. We have tried to integrate, formulate, and extend some elements of oligopoly theory and to test the resulting hypotheses. The hypothesis and finding that affects rate of return is greatly strengthened by the more complex interaction hypotheses and findings.1 In carrying out this major goal we also examine the effects of both firm and industry growth on profits, develop new evidence on leverage as a measure of risk, comment on the controversy over the correct measure of profitability, and introduce the concept of market as a so;urce of product differentiation. The paper contains four major sections. The first section develops the theoretical relationship between and profitability. This discussion focuses on the interaction effects on profitability of and the market environReceived for publication September 30, 1971. Revision accepted for publication June 21, 1972. * I am indebted to Ronald G. Ehrenberg, Kenneth Gordon, Marshall C. Howard, James K. Kindahl, Thomas Muench, and George Treyz and two referees for comments and suggestions on an earlier draft of this paper and to Patricia M. Anderson for programming services and comments. ' The interaction findings, especially the growth interaction, support the case for interpreting the data in this cross-section study as representing the effect of on profitability. An examination of the dynamic process by which firms alter their market positions would require time-series data. (See Gale, 1972.)

tempted to go a little further and suggest that the degree of concentration as such does not contribute materially to the explanation of high profitability. Perhaps this is not surprising because although a highly concentrated industry may be associated with high profitability a large number of situations are possible depending, amongst other things, on whether the industry is expanding or contracting, and on the degree of internal, intra industry, and potential competition. Secondly, the analysis shows clearly the importance of very high barriers to entry arising for instance, from control over raw materials, patent protection and economies of scale. In these cases the means exist whereby firms can maintain high profitability over a long run of years. A concern for barriers to entry should certainly be central to the implementation of a monopoly policy. Thirdly, the highly significant relationship between growth and profitability is a well established one,3 and any monopoly policy which is based on realised profitability should at least distinguish between fast and slow growing industries or (ideally) firms, and attempt to assess the extent to which high profitability is 'justified' by a high rate of growth. STATISTICAL APPENDIX

turities on borrowing costs has little empirical support either. In addition, these results provide little support for the more conventional assertion that a lengthening of either contract lengths or loan-tovalue ratios is indicative of a reduction of borrowing costs to home buyers. Admittedly, the strongly negative coefficient of G in equation (3) suggests that something is wrong with my original equation.10 I find little merit, however, in Lee's contention that I used an improper measure of borrowing costs and that my estimate of the income elasticity of housing demand is substantially upward biased as a result.

HIS paper attempts to supplement the T discussion initiated by Professor Simon Kuznets in his work on the impact of economic growth on size distribution of income (American Economic Review, XLV (March I955) and continued by Professor Irving Kravis (this Review, XLII (November I960). It will deal with (i) measures of income inequality, (2) determinants of differences in income dispersions in various countries, and (3) the sources and limitations of the data used, (Appendix).