MARKET

CONCENTRATION
CHAPTER - 2
ROGER CLARKE : Industrial Economics
 What is Market Concentration?
 Market concentration refers to the degree to which production
for in a particular market or industry is concentrated in the hands
of a few large firms.

 Market is said to be more concentrated if there are fewer no of

firms or more unequal the distribution of market shares.

 Low concentration highly competitive industry

 High concentration oligopolistic or monopolistic industry

 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.
 Concentration Measures
 Concentration Indices should be:
• Easy to compute
• Independent of the market size
• Easy to interpret;
if the range is an interval: ∈[0,1]

Perfect Competition Monopoly

 Concentration measures are related to concentration curves

 CONCENTRATION CURVE
 Concentration curve describes the relation between the accumulated percentage of the
total production/sales in the market and the accumulated number of firms in the
market ordered according to the firms’ size ranked from the largest to the smallest.

 The inequality in firms’ sizes

is expressed by the concavity
of the concentration curve
 Concentration is said to
be higher in an industry
whose concentration
curve lies everywhere
above that of another
industry.
Market A is the more concentrated; Market D is the least
concentrated; The curves B and C lead to an ambiguous
classification (market B has less firms but less size inequality)
Assessing The Feasibility Of Concentration
curve
Hannah and Kay (1977) listed the characteristics that a
concentration curve should have:

1. Concentration curve ranking criteria

2. Sales transfer principle

3. Entry condition

4. Merger condition
 1. Concentration curve ranking
criteria - Index should classify
market A as more concentrated
than market B.

2. Sales transfer principle - A

transfer of sales from a small firm
to a large one should increase the
concentration index (as seen by
dashed section of the curve).
3. Entry condition - The entry of a small firm (keeping constant the relative
shares of the existing firms) should decrease the concentration index. The
opposite in the case of an exit of a small firm.
[Note: The entry of a sufficient large firm may increase concentration.]

4. Merger condition - The merger of 2 or more firms should increase the

concentration index since the merger may be decomposed as ≈
The dashed
bulge extends
up to 100%
line.

 These criteria are insufficient to rank industries unambiguously when

concentration curves cross.
 CONCENTRATION INDEX
A Concentration index is a summary representation of a
concentration curve.

n firms , xi (i=1,2...,n) output ,

 industry output x= x1+x2+x3+........xn

 si (market share) = xi/x

TYPES OF CONCENTRATION INDEX

1. Reciprocal of firm numbers

2. Concentration ratio

3. Hirschman – Herfindhal index

4. Hannah and Kay’s indices

 RECIPROCAL OF FIRM
NUMBERS
It is the simplest possible concentration index denoted by 1/n.

Ideal when all firms in the market are of the same size. It gives zero
weight to the relative sizes of firms.

Does not satisfy the Hannah and Kay criteria of “transfer of sales”
since a transfer of sales (keeping the number of firms constant) does
not affect the index.
 CONCENTRATION RATIO
 Most widely used concentration index is concentration ratio.
 Cr - is the sum of the market shares of the largest r firms in the
market

 It is easy to compute since we only need information on the r

largest firms
 It is easy to interpret since:
 Protects the privacy of
those surveyed
Hypothetical Examples:
Concentration Ratios

For thisthat
Note
Note industry,
thatthe the Concentration
thelargest
largest four hadRatio
firmfirms (byoftogether
added
sales largest fourhad
$1 billion firms) would
sales
in 2006, of $2.7
which
Let’s assume
be 92.5%. billion this
Production table
iswas describes
heavily the
concentrated U.S.
in theDog Food
four industry.Industry.
largest firms.
in 2006, which
34% was 92.5%
of the of the
industry.
 Note
Note
Let’sFor
that
this
that
assumetheindustry,
the
largest
thislargest
the
tablefirm
four
Concentration
had
firms
describessalesadded
the of $100,000
Ratio
U.S.together
would
Retail in
had
2006,
besales
Bakery 1.8%.
which
of
Industry.
Production
$272,000
is NOT in heavily
2006,
was 0.7%which
concentrated
of was
the industry.
1.8%in of
thethe
four
industry.
largest firms.
 CRITICISM OF CONCENTARTION
RATIO
 r is arbitrarily chosen
 Only takes information from 1 point of the concentration curve. For
example- industries B and C have different ranking depending on the
value of r
 A transfer of sales may not affect the index. The index may take the
same value for two industries when in fact one of them is much more
concentrated than the other. For example, in the next table, the two
industries have the same C4 but industry 1 is more concentrated than
2.
 HIRSCHMAN- HERFINDAL
INDEX
 It has become popular among industrial economics in the last few
years.

 By squaring it gives more weight to larger firms.

 Unlike concentration ratio, it takes all points on the concentration
curve.
 H index takes inequality between each firm and every other one, while
concentration ratio reflects inequality between two groups- leading n
firms and the rest.
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
 H can also be written as :-
H = (c2 +1)/n , c=sigma/mean of x
H index depends both on market share inequality (measured by c2)
and on firm numbers, n.
 maximum value = 1 (c2 =0, n=1) for monopoly
minimum value = 0 (c2 =0, n  ∞) for many small equally sized firms
 reciprocal (1/H) = numbers equivalent, represents the number of
equal-sized firms that would give rise to the same value of the
concentration index. For example H= 0.385 ⇒ n*=2.59 (this means the
market is as concentrated as a market with n* firms of equal size)
 It satisfies each of Hannah and Kay’s criteria.
 HANNAH AND KAY INDICES
 Thisnindex is based on the generalization
R=  Si where α > 0
i 1

n
HK = (  Si ) 1/1-α α > 0, not equal to 1
i 1

 Relevant where concentration curves cross.

 They allow greater weight to be attached to large firms by
increasing he value of α.
 THEORIES OF CONCENTRATION
 In this topic, we focus on the more immediate questions of why
concentration is high in some industries but not others, and why it
may decline or increase.

 Here, we approach two very different kinds of concentration

problem :-
1. Scale economies and
2. Stochastic explanation.
 SCALE ECONOMIES
 Economies of scale exist when the production cost of single product
decreases with the number of units produced.

 In achieving economies of scale, main factor is technology.

Technological factors play a central role in determining efficient

level of plant operation.
 Analysis
 It does not address the aspect of market share inequality of market
concentration.
 It emphasizes on scale economies relative to market size rather
than scale economies alone. So if the market size is large, there
could be many large firms.
 It is a long-run equilibrium theory, the shift from LAC1 to LAC2
might take many years to establish.

However,
 LAC curves are L-shaped rather than U-shaped. Hence we get to
know a lower bound to concentration.
 The equilibrium price could be greater (as is the case in oligopolistic
or monopolistic markets).
 Example of natural monopoly
• Represents extreme case of concentration being determined by
presence of scale economies.
• 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
𝑃  0

𝑄  0
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
They may limit the number of the firm.
They may preserve or protect the market share of those firm
those are already established in it.
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.
Barriers to entry preserve the status quo in terms of relative firm
size and overall market concentration.
 STOCHASTIC APPROACH
 Stochastic approach emphasize the multitude of factors which
determine actual concentration change and rationalize the typically
observed distribution of firms by size within an industry.

 Among these influences we might list such things as days lost

through strikes, exchange rate movement, the success of an
advertising campaign or a new product launch, the success of a
merger, a change in a competitor’s price policy and many others.
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.