Concentration ratio
A concentration ratio is the ratio of the combined market shares of a given number of firms to the whole market size. It is commonest to consider the 3-firm, 4-firm or 5-firm concentration ratio. Concentration ratios are used to assess the extent to which a given market is oligopolistic. Although there is no definitive 'rule' about what ratio constitutes an oligopoly, a 4-firm concentration ratio of over 60% would indicate a highly oligopolistic market.Now read this
Market concentration measures the extent to which sales in a market are dominated by one or more businesses
What is market concentration and how is it measured?
- The concentration ratio measures the combined market share of the top 'n' firms in the industry.
- Share can be by sales, employment or any other relevant indicator.
- The value of 'n' is often five, but may be three or any other small number. If the top 'n' firms gain a high market share the industry is said to have become more highly concentrated.
The Herfindahl-Hirschman Index (HHI)
This is a measure of market concentration. The index is calculated by squaring the % market share of each firm in the market and summing these numbers.
For example in a market consisting of only four firms with shares of 30%, 30%, 20% and 20% the Herfindahl Index would be 2600 (900 + 900+ 400+ 400).
For example, if a local radio station market consisted of two companies with 40 per cent each, and of two companies with 10 per cent each, it would have an HHI of 3,400
The superior quality and accuracy of the Herfindahl Index over the simple concentration ratio can be seen when three markets are examined each with a four firm concentration ratio of 85%.
Assume that in each market the remaining 15% of the market is controlled by 15 firms each with 1% market share.
This is a measure of market concentration. The index is calculated by squaring the % market share of each firm in the market and summing these numbers.
For example in a market consisting of only four firms with shares of 30%, 30%, 20% and 20% the Herfindahl Index would be 2600 (900 + 900+ 400+ 400).
- The index can be as high as 10,000 if the market is a pure monopoly (100*)
- The lower the index the more competitive the market is and can reach almost zero for perfect competition
- If an industry has 1000 companies each with 0.1% market share then the index would only be 10 (1000 x 0.1*).
For example, if a local radio station market consisted of two companies with 40 per cent each, and of two companies with 10 per cent each, it would have an HHI of 3,400
The superior quality and accuracy of the Herfindahl Index over the simple concentration ratio can be seen when three markets are examined each with a four firm concentration ratio of 85%.
Assume that in each market the remaining 15% of the market is controlled by 15 firms each with 1% market share.
- Market A: 40% 20% 20% 5% = 85% - Herfindahl Index = 2440
- Market B: 25% 20% 20% 20% = 85% - Herfindahl Index =1840
- Market C: 75% 5% 3% 2% = 85% Herfindahl Index = 5678
