Chapter 10: a. Discussion Questions: 2, 4(a), 8, and 11. 2. a) What are the adva
ID: 1237797 • Letter: C
Question
Chapter 10:a. Discussion Questions: 2, 4(a), 8, and 11.
2. a) What are the advantages of the Herfindahl index over concentration ratios in measuring the degree of concentration in an industry?
b) What is the disadvantage of both?
4. a) What is meant by the Cournot model?
8. In what way does OPEC resemble a cartel? How successful is it?
11. What is the most important reason for the rise and rapid spread of global oligopolists?
b. Problems: 1 and 5*.
1. Find the Herfindahl indes for an industry composed of (a) three firms
Explanation / Answer
The Herfindahl index is a measure of industry concentration. It was developed to provide an alternative measure of the relative market control of the largest firms to that found with the four-firm and eight-firm concentration ratios. The Herfindahl index is named after Orris C. Herfindahl, the economist first credited with using it to analyze industry concentration. However, upon further review, another economist, Albert O. Hirschman, was found to have used this index earlier. As such, it is often termed the Herfindahl-Hirschman Index. Disadvantage are as follows: The Herfindahl index, however, is not without a few problems. The first problem is to find meaning in the numbers. While a four-firm concentration ratio of 61.25 percent MEANS that the top four firms in the industry account for 61.25 percent of total industry sales, what does an Herfindahl index of 1177 really mean? There is no obvious intuitive meaning to the Herfindahl index. Along this same line of thought, another problem with the Herfindahl index is the choice of squaring market shares. There is no particular reason, theoretical or otherwise, to square the market share for each firm. Squaring each share does give greater importance to firms with larger market shares, but these shares could just as easily be cubed, or raised to the fourth, fifth, or sixth power. A third problem with the Herfindahl index is that it requires a substantial amount of information, more than that for concentration ratios. The only information needed to calculate a four-firm concentration ratio is the market shares of the top four firms. However, to calculate a Herfindahl index, the market share for every firm in the industry is needed. In that some oligopolistic industries have a few large firms, and dozens, even hundreds of smaller firms, obtaining the needed information can be quite a chore. A Cournot model is a generalization of the Cournot game to describe industry structure. Each of N firms will choose a quantity of output. Price is a commonly-known decreasing functions of total output. All firms know N and take the output of the others as given. Each firm has a cost function ci(qi). Usually the cost functions are treated as common knowledge. Often the cost functions are assumed to be the same for all firms. For years it was fashionable to use the Organization of Petroleum Exporting Countries (OPEC) as an example of a successful cartel. OPEC greatly raised the price consumers pay for oil products, made a fantastic amount of money, and has survived for years. Today, however, its returns are much smaller than in its heyday. OPEC is a profit-maximizing cartel. The cartel agreement may break apart from time to time (countries produce too much output), but OPEC generally is able to meet and reestablish the cartel. A slight variant of this theory holds that OPEC countries have different discount rates and hence disagree on setting a price to maximize the present discounted value of profits. Saudi Arabia is a dominant firm. Saudi Arabia by itself (or possibly in conjunction with a small core group within OPEC) acts as a dominant firm by restricting its own output. As the world's biggest producer, Saudi Arabia does not have to rely on the other more volatile countries within OPEC.
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