Industry Concentration

How can you tell what market structure

an industry is in?
(In other words, how do you know if a business in a
monopolist, perfectly competitive, or something in between?)
Reflect on your market’s characteristics
Should I advertise a lot? And if so…do I
You can then use the table to interpret the product differentiate?

characteristics of the market you will be Do I have pricing power or am I a price

taker?
competing in. Once complete, you’ll be able
Are my price changes dependent on
to answer key questions about your market! other firms?
Can I expect tough barriers to entry?
What is Market Concentration?

• Market Share in simple terms is the proportion of sales

relative to other firms.

• Market concentration refers to the degree to which

production for or in a particular market or industry is
concentrated in the hands of few large firms.

• In measuring Market concentration we are concerned

with individual markets or industries, and with the
number and relative size of firms of each industry.

• Market is said to be more concentrated if there are

fewer no of firms or more unequal the distribution of
market shares.
Aggregate Concentration

Aggregate concentration relates to the degree to which a

few large firms control the production of economy as a
whole or at least broad sectors of it, such as financial and
manufacturing sector.
Measuring an industry’s concentration

There are two ways to

1. Concentration ratio measure an industry’s
concentration. Interpreting
that will allow you to see what
2. Herfindahl Index market structure an industry
is in!

If you watch “The Office” you’ve heard the about Herfindal index
in Michael’s speech to the MBA class.
Questioner: What has happened to your
Herfindahl index since the merger?
Michael: I don’t know. How is your
“nerdsayswhat” index?
Questioner: What?
Michael: That is what I thought, Poindexter.
 Concentration Ratio

1. Concentration ratio

The concentration measures an

industry’s concentration by examining
the share of output controlled by the
largest four firms in that industry

– This could be measured in terms of sales,

value added, or other metric
– Data are published every 5 years by the
Census Bureau in the Economic Census
 Concentration Ratio
Hypothetical Examples:
Concentration Ratios

Forthat
Note
Note thisthe
that industry,
the largestthe
largestfour Concentration
firm firms Ratio
addedoftogether
had sales would
had
$1 billion in be 92.5%.
sales
2006, of $2.7
which
Let’s assume this table describes the U.S. Dog Food Industry.
Production
billionisinheavily
2006, concentrated
waswhich
34% was in the
92.5%
of the of four
industry. largest firms.
the industry.
 Concentration Ratio
Hypothetical Examples:
Concentration Ratios

Let’s
NoteFor
Note this
that
that
assume industry,
thethe
largest
this the
largest
tablefirmConcentration
four
had
firms
describessalesadded
the of Ratio would
$100,000
U.S.together
Retail in
hadbesales
1.8%.
2006,
Bakery which
of
Industry.
Production is NOT
$272,000 in heavily
2006,
was 0.7% concentrated
which of was in of
thethe
the industry.
1.8% four largest firms.
industry.
 Concentration Ratio

Interpreting the Concentration Ratio

With a Concentration With a Concentration

Ratio of 1.8%, the Ratio of 92.5%, the
Hypothetical Retail Hypothetical Dog Food
Bakery Industry is near Industry is near
Perfect Competition Monopoly

100%
0%

40%

Perfect
Monopolistic Monopolistic
Competition Oligopolistic
Competition
 Concentration Ratio
There is a problem with
the Concentration Ratio

• If four firms share all output, their

Concentration Ratio is equal to
100% but they are not a monopoly

• But if one firm is the sole producer,

its Concentration Ratio is equal to
100% and it is a monopolist
 Herfindahl Index
The Herfindahl Index
solves this problem

The Herfindahl Index is

calculated in three steps:

1. Determine the percent of output

produced by each of the largest
all firms.
Formula of HH Index-
H= Ʃ𝑆𝑖2

2. Square each of those share

3. Add all the squared numbers

 Herfindahl Index
Hypothetical Example:
Herfindahl Index

For
The this
Note
same industry,
that the Herfindahl
calculation
the largest was
firm made Index
had sales ofis$1
for each 2,415.
ofbillion We
the four will
in 2006, interpret
largestwhich
firms
Let’s34%
was assume
of thethis tablefigures
Those
industry. describes
that figure
That the
weresoon.
figure thenU.S.
squared Dog
added. Food (34x34).
is 1,157 Industry.
 Herfindahl Index
Hypothetical Example:
Herfindahl Index

Let’s
For
The this
Note
same industry,
that
assume thetable
calculation
the largest
this Herfindahl
was Index
firmdescribes
had
made sales ofis$1
forthe
each 6,347.
U.S.
of
million
the We
Cat four
Foodwill
in 2006,interpret
largest
Industry.
which
firms
was 79.2% of the Those thatThat
industry. figure
figures weresoon.
figure
thensquared
added.is 6,279 (79x79).
 Herfindahl Index

Interpreting the Concentration Index

With a Herfindahl Index With a Herfindahl Index

of 2,415, the hypothetical of 6,347, the hypothetical
Dog Food Industry is Cat Food Industry is
somewhat concentrated. more heavily
concentrated.

10,000
1,500 2,500
0

Moderate Acute Concentration

Concentration
Interpret the Concentration Index

Once you have obtained the concentration ratio, use the

spectrum below to interpret your business’ market structure

100%
0%

Perfect
Monopolistic Monopolistic
Competition Oligopolistic
Competition (95%+)
(0%-5%) (40%-90%)
(5%-40%)
Note that these percentages are estimates and subject to interpretation.
 Herfindahl Index
Hypothetical Example:
Herfindahl Index The Concentration
Ratio would look the
same for these two
industries, but the
Herfindahl Index
really shows
differences in
market
concentration

Notice that the top

four industries each
comprise about 92%
of the industry…
But for cat food, the
largest is really
dominant
Sources Of Concentration

• Major dimension of market structure, but not a

permanent feature.
• Several factors that influence both the number
and the relative size of the firms
• Some are natural and some are artificial
• NATURAL – Economies of scale and barriers
• ARTIFICIAL- includes acts of strategic behaviour
NATURAL
FACTORS
Scale Economies

• Cost advantages enjoyed by large firms

• Size of the plant, experience, technical advantage
etc.
• Reflects that cost savings are attained by large firms.
But firm size is half the picture.
• Size of the market bears equal responsibility,
determined by demand.
• Once, market size is given, firm size determines its
market share and by extension, the level of natural
concentration.
Let’s understand with natural monopoly

• Represents extreme case of

concentration.
• Assume demand and cost given, LRAC
declines throughout the output.
• Price equal to AC and output determined
by the corresponding quantity demanded,
the firm continues to experience
increasing returns to scale.
• Under these circumstances, monopoly is a
natural or equilibrium state.
Price

LRAC
𝑃0
D

𝑄0
Quantity
Three Scenarios That Can Happen

1. More than one firm- larger would have a

cost advantage and would seize the
monopoly by undercutting the rival’s
price.
2. More than one firm but equal size-
combine in order to seize to seize the
cost advantages of Natural Monopoly.
3. But if there was only one firm and it were
to price in this fashion, no entrant would
be willing or able to challenge its position
of monopoly.
Barriers to entry

1. They may limit the number of the firm

2. They may preserve or protect the market share
of those firm those are already established in it.
3. The firm which enjoys a barriers to entry
advantage is able to produce its product at a
lower cost or to market its product more easily
than the competition
Random forces affecting concentration

Gibrat offered the hypothesis that , behind the size

distribution , was a universal process of random growth
common to all firms .
Properties
1) Each firm was expected to grow in the same proportion ,
as every other.
2) Each firm actual growth was determined by random
variable term.

This process is also known as LAW OF PROPORTIONATE

GROWTH ,because firm growth is random , the process can
generate differences in firm sizes.
THANK YOU
Srijan Saxena- 15/2038
Sharan Saini- 15/2042
Akshit Gupta- 15/2043
Bharat Kumar- 15/2044
Chanderkant- 15/2046