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8.3: Measuring Market Structure

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    210859
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    Concentration Ratio

    There are two common methods to measure concentration in an industry.

    The concentration ratio is a measure of market power that relates the size of firms to the size of the market. The concentration ratio is the proportion of total industry output produced by the largest firms (usually the four largest). It is generally accepted that any industry with a concentration of at least 70% is considered oligopolistic. See figure 7.

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    Figure 7

    Limitations

    The concentration ratio has a few limitations when evaluating an industry’s market power. First, market power isn’t necessarily associated with firm size. A small firm could possess a lot of power in a relatively small market. For example, a local daily newspaper may have a significant market share of the local market but a very small share nationwide. Secondly, one cannot get a complete picture of the industry because only four firms are used in the calculation.

    Table 1 shows the concentration ratios of broadly defined industries. Note the market share totals of the four largest firms in their respective industries.

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    Table 1

    Table 2 contains a list of narrowly defined industries. Note the market shares of the four largest firms. The market shares are, on average, much larger than the broadly defined industries in table 1.

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    Table 2

    For example, in table1 the Arts, entertainment, and recreation industry listed in table 1 has a four-firm concentration ratio of 8%. Video game consoles are a part of the Arts, entertainment, and recreation industry. Table 2 lists many narrowly defined industries. The video console industry has a 100% concentration ratio.

    Herfindahl-Hirshman Index (HHI)

    The Herfindahl-Hirshman index (HHI) is a measure of industry concentration that accounts for all the firms and their sizes.

    The HHI is calculated by squaring the market share of each firm in the industry and then summing the resulting numbers.

    \[\begin{gathered}
    HHI=\sum_{i=1}^n\binom{\text { share of }}{\text { firm i }}^2 \\
    HHI=\sum \left(\begin{array}{c}
    \text { share of } \\
    \text { firm 1 }
    \end{array}\right)^2+\binom{\text { share of }}{\text { firm 2 }}^2+\cdots \cdot\binom{\text { share of }}{\text { firm } n}^2
    \end{gathered} \nonumber \]

    The higher the HHI, the more concentrated and less competitive the market is. The lower the HHI, the more diverse and competitive the market is. The HHI can range from 0 to 10,000, with different thresholds indicating different levels of market concentration.

    For example, for a market consisting of five firms with shares of 30%, 30%, 20%, 10% and 10%, the HHI is:

    \[30^2+30^2+20^2+10^2+10^2=2400\nonumber \]

    The U.S. Department of Justice uses the HHI to assess the antitrust implications of proposed mergers and acquisitions, and to determine whether they would harm consumers or reduce social welfare.

    According to the Department of Justice, markets in which the HHI is between 1500 and 1800 points are moderately concentrated, and those in which the HHI is more than 1800 points are considered to be highly concentrated.

    Mergers or acquisitions of firms that increase the HHI by more than 200 points or a score over 1800 presumptively raise antitrust concerns.


    This page titled 8.3: Measuring Market Structure is shared under a not declared license and was authored, remixed, and/or curated by Martin Medeiros.

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