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Unit 2.7:

Market (industry)concentration

(Additional notes)

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Outcomes – Define, explain (problems and examples),

calculate and interpret the: – Concentration ratio (CR)

• Herfindahl-Hirschman index (HHI)

• Discuss the advantages and critique of the HHIand CR.

• Recalculate the HHI and CR to explain the effect of

merging on the economy given the HHI criteria.• Discuss the shortcomings of concentration

standards.

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Concentration Ratio (CR)• Percentage of industries sales accounted for by

x number of firms in the industry (e.g. CR4,CR8)

• High CR versus low CR? – Eg. CR4 = 90% versus CR4 = 15%

• Can you think of SA examples with high CR?

• Problems with CR• Foreign competition• Intensity of competition among firms

• Degree of barriers to enter

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Herfindahl-Hirschman index (HHI)• Measures the degree of concentration in an

industry. It is equal to the sum of the squares ofthe market share of each firm in the industry.

• HHI = (S1)² + (S2)² + (S3)²….(Sn)² – Please make sure that you can calculate the market

share from sales data!

• Advantage of HHI over CR4?• Critique of HHI and CR4?• No direct relationship between size and market

power!

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What are the advantages of HHIover CR4

• HHI reflects both the distribution of themarket share of the top 4 firms & thecomposition of the rest of the market.

• HHI allocates a proportional larger weightto the market shares of larger firms.Acknowledgement of the larger firm’s

relative importance in competitiveinteractions.

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HHI

between:

Concentration Change in HHI

in case ofmerger:0 – 999 Unconcentrated

industry /competitiveindustry

No competitive

concern

1 000 – 1800 Moderatlyconcentratedindustry

> 100 = raisescompetitiveconcern

1 800 – 9 999

Highlyconcentratedindustry

> 50 = raisescompetitiveconcern

10 000 Monopoly

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Example:

Firm Sales Marketshare (%)

A 24000 15

B 19200 12C 17600 11

D 16000 10

E 12800 8

F 11200 7G 11200 7

H 9600 6

I 9600 6

J 9600 6

K 9600 6

L 9600 6

• CR4 =

• HHI =

• HHI if merger = 2 x marketshare A x market share B

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Problems with concentrationmeasures

• The competition of imports are ignored• Use national data – domination in small

areas are not considered

• Entry – only current firms are beingconsidered• Competition is not 1 dimensional- Indirect substitutes are just as important as

direct substitutes