Measuring Market Structure

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Measuring Market Structure
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Concentration ratios We have seen that the two
polar extremes of market structure are monopoly,
with one firm, and perfect competition, where
there are many firms. Plus, we saw that the
perfect competition situation was more efficient
in the sense that total surplus for producers and
consumers together was maximized. In the real
world of business we see the number of firms
varies from industry to industry. In an attempt
to find a numerical measure to indicate which
industries are more like monopoly and which are
more like competition, concentration ratios were
devised. Concentration ratios typically use
percentage of output produced as the concept used
in the numerical measure.
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• Concentration ratios
• CRn is the output added across the n largest
  firms in an industry divided by the total
  industry output(and then multiply the result by
  100 to be in percentage terms). For example, CR4
  is the output of the 4 largest firms added
  together divided by total output in the industry.
• Examples
• Monopoly industry gt CR4 100,
• Industry with 4 firms of equal size (25 of sales
  for each) -gt CR4 100.
• Can you tell which of the examples above has only
  one firm by just looking at the CR4? Of course
  not!

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• More examples
• 10 firms, each with 10 of market -gt CR4 40,
• 4 firms, each with 10, and 30 firms, each with
  2 -gt CR4 40.
• Here we have two examples of industries where the
  CR4 is the same. But we see the remaining firms
  after the top 4 are very different in each
  example. You would see this by looking at the
  CR8, but not all the time. So, another measure
  has been added and the measure considers all the
  firms in an industry (or maybe the top 50 firms).
  The measure is the HHI

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• Herfindahl-Hirschman Index HHI
• To get the HHI we need the market share of each
  firm in percentage terms. Then we square the
  market share of each firm. After this, simply
  add the squared market share of each firm to get
  the final number.
• Examples
• Monopoly -gt HHI 1002 10,000. This is as big
  as you can get.
• 4 firms with 25 each -gt HHI 252 252 252
  252 2500
• 10 firms each with 10 -gt HHI 10 times 102
  1000.
• 4 firms with 10, 30 firms with 2 -gt HHI 4
  times 102 plus 30 times 22 400 120 520.

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HHI The closer the HHI is to 10,000 the more the
industry is like a monopoly. The closer to 0 the
more the industry is like a competitive industry.
Issues with CR4 or HHI How do we define a
market? At issue is how narrow or broad do we
define the industry. Is aluminum foil and waxed
paper in the same market? What about that
plastic wrap that gets all stuck together before
you cover the food? Should that be included with
the aluminum foil and waxed paper? The issue
raised has to be settled before we can even
calculate the CR4 or the HHI.