Industry and Economic

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  • Topic: Herfindahl index, Monopoly, Imperfect competition
  • Pages : 8 (2703 words )
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  • Published : December 4, 2012
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Calculating the Four Firm Concentration Ratio (CR4)

Definition: The four firm concentration ratio is the percentage of market share held by the largest 4 firms in an industry.

Formula: CR4= Σ4i=1 si
Calculation: (11,834,883 + 3,845,900 + 3,696,800 + 3,650,647) / 44,582,621 = 0.5165292996 = 0.516 (3dp) =51%

Analysis: As the four firm concentration ratio is >50% this insinuates that this market structure is that of an oligopoly.

Calculating the Herfindahl-Hirschman Index (HHI)

Definition: The HHI is a concentration measure based on the sum of the squared market shares of all the firms in the industry.

Formula:

Calculation: 0.1085 (4dp)

Analysis: Using HHI analysis, we have found the HHI is between 100 and 1500, resulting in it being an unconcentrated market

Lorenz Curve and Gini Coefficient

Gini Formula:

Calculation: G = (458069882/0.5*197*44582621) – 1 = -0.89569 (0.89 2DP)

Advantages and Disadvantages of the measures of Concentration

Narrowing down the market by using an ‘n’ number of firms as a measure of industry concentration is helpful for measuring concentration in extreme cases like monopoly and perfect competition. White (1981) argues that in the case of concentration within individual markets, we search for inferences in relation to the likelihood of oligopolistic coordination concerning prices and sales. The shares of the oligopoly’s themselves will be a prime determinant of the likelihood of that co-ordination, Hence, industry sales are the proper measure of concentration calculations in individual industries.

Using CR4 means that analysis of the whole industry is based on these select four, meaning it cannot capture information and performance in the rest of the industry. No account is taken of the number and size distribution of firms that are outside the top ‘n’. Furthermore, no account is taken of the size distribution within the top ‘n’ firms. CR has the ability to determine which market structure each industry is. For example by seeing that the top 4 firms of 192 companies in the UK computers industry owns 51% of market share, we can easily determine that this market is an oligopoly. However we cannot see the weighting between these four firms, and therefore distortions are still concealed.

Herfindahl-Hirschman Index (HHI) allows for complete market analysis as it takes into account all firms within an industry and the inequality of market shares. It also weights the market shares of the largest enterprises more heavily. A practical difficulty with the HH index is its requirement for individual size data on all of the industry’s member firms. This could prove difficult and very time consuming in markets where there are many sellers such as in the case of the computer industry. Unlike CR, HHI allows us to see all the firms in the market so distortions of share are evident. HHI on the other hand does not allow us to define the boundaries of the market. We know not of how easy it is for new entrants to join or whether or not smaller incumbent firms are trying to leave the market.

The Gini Coefficient’s main advantage is that it is a measure of inequality not a measure of average sales. Usually the Gini-coefficient is used to compare income distributions but other variables such as sales revenue in this case can be used. Kwok Chuen (2010) argues that inequality implied by Gini coefficients over time is misleading because Gini ignores structural changes in an industry such as new manufacturing techniques.

In final analysis of all measures of concentration it may be impossible to quantify all relevant aspects of an industry's competitive nature in a single numerical measure. For example, production methods and business objectives could differ, and empirical analysis made prove to be difficult.

Structure, Conduct and Performance analysis...
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