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Four-Firm Concentration Ratio

By dietmarjperez Dec 06, 2008 913 Words
Four-Firm Concentration Ratio
Definition of the Four- Firm Concentration Ratio This is one of the most common concentration ratios. The four-firm concentration ratio is commonly used to indicate the degree to which an industry is oligopolistic and the extent of market control held by the four largest firms in the industry. How would you describe an industry with 20 firms and the CR is 20% and its implications? The four-firm concentration ratio is calculated based on the market shares of the largest firms in the industry. Having an industry falling between 0 to 50% is commonly interpreted as an industry with low concentration ratio; the main description of this concentration is that it is a very competitive market also known as monopolistic competition. Monopolistic competition is a market structure characterized by a large number of firms which are similar but do not sell identical products, relative freedom of entry, into and exit out of the industry, and extensive knowledge of prices and technology. Monopolistic competition approximates most of the characteristics of perfect competition, but falls short of reaching the ideal benchmark, that is perfect competition. What long-run adjustments would you expect following this change in demand? First of all, since a change in demand took place, it is important to clarify the relationship between the monopolistic competition and demand. The demand curve for the output produced by a monopolistically competitive firm is relatively elastic. The firm can sell a wide range of output within a relatively narrow range of prices. Demand is relatively elastic in monopolistic competition because each firm faces competition from a large number of very, very close substitutes. However, demand is not perfectly elastic (as in perfect competition) because the output of each firm is slightly different from that of other firms. Monopolistically competitive goods are close substitutes, but not perfect substitutes. A monopolistically competitive industry undertakes a two-part adjustment to equilibrium in the long run. One is the adjustment of each monopolistically competitive firm to the appropriate factory size that maximizes long-run profit. The other is the entry of firms into the industry or exit of firms out of the industry, to eliminate economic profit or economic loss. The end result of this long-run adjustment is two equilibrium conditions--one for profit maximization, the other for zero economic profit. How would you describe an industry with 20 firms but the CR for the industry is 80% An industry with a concentration ratio of 80 to 100 percent is viewed as highly concentrated and also known as oligopoly. Government regulators are usually most concerned with industries falling into this category. Oligopoly develops in a market structure characterized by a small number of large firms that dominate the market, selling either identical or differentiated products, with significant barriers to entry into the industry. Oligopoly dominates the modern economic landscape, accounting for about half of all output produced in the economy. Oligopolistic industries are as diverse as they are widespread, ranging from breakfast cereal to cars, from computers to aircraft, from television broadcasting to pharmaceuticals, from petroleum to detergent. What are some reasons why this industry has a high CR while the other industry had a low CR? •One of the main reasons is because an oligopolistic firm is relatively large compared to the overall market; it has a substantial degree of market control. It does not have the total control over the supply side as exhibited by monopoly, but its capital is significantly greater than that of a monopolistically competitive firm. Following I will provide some other reasons. •Interdependence: Each oligopolistic firm keeps a close eye on the activities of other firms in the industry. Decisions made by one firm invariably affect others and are invariably affected by others. Competition among interdependent oligopoly firms is comparable to a game or an athletic contest. One team's success depends not only on its own actions but on the actions of its competitor. Oligopolistic firms engage in competition among the few. •Rigid Prices: Many oligopolistic industries (not all, but many) tend to keep prices relatively constant, preferring to compete in ways that do not involve changing the price. The prime reason for rigid prices is that competitors are likely to match price decreases, but not price increases. As such, a firm has little to gain from changing prices. •Mergers: Oligopolistic firms perpetually balance competition against cooperation. One way to pursue cooperation is through merger--legally combining two separate firms into a single firm. Because oligopolistic industries have a small number of firms, the incentive to merge is quite high. Doing so then gives the resulting firm greater market control. Is it possible for smaller firms to thrive and profit in such an industry? For smaller firms it is very difficult to enter and much less become profitable, the reason why is because in a oligopolistic industry the market control is retained through barriers to entry. The most common barriers to entry include patents, resource ownership, government franchises, start-up cost, brand name recognition, and decreasing average cost. Each of these makes it extremely difficult, if not impossible, for potential firms to enter the industry.

References
FOUR-FIRM CONCENTRATION RATIO (2008). AmosWEB Encyclonomic WEB*pedia. Retrieved from http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=four-firm+concentration+ratio on November 29, 2008. O’Sullivan, Sheffrin and Perez (2008). Economics: Principles, Applications, and Tools. Upper

Saddle River, NJ: Pearson Prentice Hall.

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