Measures of Concentration

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  • Topic: Herfindahl index, Monopoly, Price discrimination
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  • Published : March 19, 2013
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Measures of
Concentration

Monopoly Market Power

• “It is a ability of firm to set the price of a good or

service without risking the loss of its entire market
share”
• Price taker and Price maker
• Examples: Indian Railways

Sources of Market Power

 Lack of rival firms
 Customer Preference
 Location
 Product differentiation

What is Measures of concentration?
 “In economics, market concentration is a function of

numbers of firms and their respective shares of the total

production in a market”
 Degree of market concentration

Cont….
 It is the measure of shares of different companies in a particular

industry.
Example:-

Nokia(Indian market)42%
 Primarily two types of Concentration:-

1.Highly Concentrated  Electricity(100%) – 1.00
2.Unconcentrated  Car Industry, Mobile Industry

Methods to measure concentration

 Concentration ratio (CR)

 Herfindahl’s index (H-index)
 Learner’s index (l-index)

What is Concentration ratio?
 It is the ratio of market share of a particular firm/company to that

of the whole industry.
Example-Mobile phone industry
Mobile
Manufacturers

Market share(%)

CR

Nokia

42

0.42

Samsung

27

0.27

LG

11

0.11

Four-Firm Concentration Ratio
 Four-Firm Concentration Ratio
 It is the percentage of total industry sales made by top 4 largest firms

of an industry.

Example:-4 companies S1 ,S2 ,S3 and S4
C R m = s1 + s2 + s3 + s4
where si is the market share.
 Varies from 0 to 100( depends on low, medium or high concentration).

Cont’d…..
 Example of CR

market shares of telecommunication industry
Airtel = 35%

Reliance = 22%
BSNL = 12%

Tata Indicom = 11%
So CR= (35+22+12+11)%
CR= 80%

Herfindahl’s Index (HHI)
 Widely used method to measure the degree of concentration  It is given by the sum of squared values of market share of the

firms in an industry.

 H-index gives more weightage to larger firms of industry.  Smaller firms are left out

Cont’d……
 Varies from 0 to 100 %.
 H-index gives more weight to largest firms of industry.

Example:Mobile Operating systems(World market)
Android  29%
Apple  27%
Blackberry  27%

Windows Mobile  10%
Symbian  5%
Others  2%

Therefore,
HHI = (29)2 + (27)2 + (10)2 + (5)2 = 2324

Evaluation of H-index
 Single firm with 100% share

H= 1*(100)^2
H= 10,000
 1000 equal sized firms (so each have 0.1 % share)

H=1000*(0.1)^2
H=10
 11 industries 1 with 50% share and other 10 are with 5% each

H= 1*(50)^2+10*(5)^2

H= 2750

Advantages of H-index

 Wide amount of data is taken into account
 Helps Government in determining firms who are gaining

monopoly power.
 Usual Government standards:-

2000  Highly Concentrated
1000 or less  Un-concentrated

Learner’s Index
 It is the method to measure the degree of firm’s monopoly

power.
 It is also known as price-cost margin or price cost markup.

 It is given by the ratio of difference between price(P) and

marginal cost(MC) to price.
L = (P-MC)/P
 Varies from 0 to 1.

Derivation of L=(P-MC)/P
• MC = MR
MC = d(TR)/dQ
MC= d(P(Q).Q)/dQ
MC= P + Q(dP/dQ)
MC= P [1+ (Q/P)(dP/dQ)]
MC= P [1-(1/e)]
where “e” is a price elasticity of demand.
(P-MC)/P=1/e
where 1/e –profit maximizing mark up over price
 Mark up of price over marginal cost divided by price is called Lerner’s index of monopoly

power.

Difficulties arise by using L-index

 A firm with a great deal of monopoly power may keep it’s price low to

avoid legal scrutiny (to deter entry into the industry).

 Learner index is applicable in static context but it is not very useful in

dynamic context when firm’s demand and cost function shift over time.

Three conclusions of Concentration Ratios
If an industry becomes more concentrated will firms monopolize the price of their products ?
 Even after an increase in concentration ,the...
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