Answer the following questions, which relate to measures of concentration: What

Question

Answer the following questions, which relate to measures of concentration: What is the meaning of a four-firm concentration ratio of 60 percent? 90 percent? What are the shortcomings of concentration ratios as measures of monopoly power? Suppose that the five firms in industry A have annual sales of 30, 30, 20, 10, and 10 percent of total industry sales. For the five firms in industry B, the figures are 60, 25, 5, 5, and 5 percent. Calculate the Herfindahl index for each industry and compare their likely competitiveness.

Explanation / Answer

The meaning of four firm concentration ratio of 60% is that the top four firms (i.e firms with highest shares) in that industry has 60% of the market share.

The meaning of four firm concentration ratio of 90% is that the top four firms (i.e firms with highest shares) in that industry has 90% of the market share.

The shortcoming of four firm concentration ratio is that it doesn't look at the concentration of the entire industry , i.e it doesn't look at how the market share of rest of the industry other than those top 4 firms is distributed.

Herfindahl index for industry A

= 30^2 + 30^2 + 20^2 + 10^2 + 10^2

= 900 + 900 + 400 + 100 + 100

= 2800

Herfindahl index for industry B

= 60^2 + 25^2 + 5^2 + 5^2 + 5^2

= 3600 + 625 + 25 + 25 + 25

= 4300

So, Since Herfindahl Index of industry A is less then that of industry B , So firms are less concentrated in industry A then B

Hence , Competition is More in Industry A then in Industry B.

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