Applied Project
It is a group assignment (20%)
 5% on presentation (11/30 @11:00 am)
 Slides due 11/29 @ 5:00 pm
 15% on paperwork (due 12/4@7:30 am)
1
Question 6

How would you describe the market structure of the
industry in which your firm operates? To answer this, you
should discuss the number of competitors, product
similarity and barriers to entry. Does the firm have pricing
power?
Measuring Concentration
Market structrue
Measuring Concentration


Count the number of firms in industry
Concentration Ratio
- CRm: the market share of the top m firms
- CR4(four-firm concentration ratio): the
percent of industry sales accounted for by
the top four firms
-Although there is no definitive 'rule' about what ratio
constitutes an oligopoly, a 4-firm concentration ratio of
over 60% would indicate a highly oligopolistic market
Measuring Concentration


Although there is no definitive 'rule' about what ratio
constitutes an oligopoly, a 4-firm concentration ratio of
over 60% would indicate a highly oligopolistic market.
A 4-firm concentration ration less than 40% would
indicate monopolistically competitive
Market Structure
Measuring Industry Concentration

•
•
7-6
Four-firm concentration ratio:
, , and
denote the sales of the four largest firms in an
industry
denotes the total sales of all firms in the industry
Measuring Industry Concetration
=
+ + +

: market share of firm i
 The ration is the sum of the market shares of the top
four firms
Measuring Industry Concentration
Market Structure
in Action


Suppose an industry is composed of six firms. Four firms
have sales of $10 each, and two firms haves sales of $5
each. What is the four-firm concentration ratio for this
industry?
Answer:

Total industry sales are
$50.
Sales of the four largest firms are $40.

The four-firm concentration ratio is:

0.80
The four largest firms in the industry account for 80 percent of
total industry output.

7-8
$
$
$
$
$
Measuring Industry Concentration
Problem:
=(0.97, 0.01, 0.01, 0.01)
EX1:
=(0.25,0.25,0.25,0.25)
EX2:
7-9
Market Structure
Measuring Industry Concentration
Herfindahl-Hirschman index (HHI):
10,000



7-10
The sum of the squared market shares of firms in a given
industry multiply by 10,000
Big firm gets higher weight
Small firm gets smaller weight
Market Structure
Measuring Industry Concentration
Herfindahl-Hirschman index (HHI):
 Industry A: 1/2, 1/4, 1/4
=> H1=3/8
 Industry B: 1/3, 1/3, 1/3
=> H2=1/3
Therefore, H1>H2: A is more concentrated than B
7-11
Market Structure
Measuring Industry Concentration
In Action
Industry
C4
(percentage
)
HHI
Distilleries
70
1,519
Fluid milk
46
1,075
Motor vehicles
68
1,744
Snack foods
53
1,984
Furniture and related products
11
62
Semiconductor and other electronic
components
34
476
Soft drinks
52
891
7-12
Measuring Market Power

Lerner index
A measure of the difference between price and marginal cost
as a fraction of the product’s price.

rearranging this equation yields
1
1
, where
7-13
is the markup factor over marginal costs.
Measuring Market Power

A firm in the airline industry has a marginal cost of $200 and
charges a price of $300. What are the Lerner index and
markup factor?


The Lerner index is
The markup factor is
1
1
1
3
1.5
1
1
3
For each $1 paid to a firm in the airline industry, 33 cents is markup
1
•
$300 $200
$300
7-14
Conduct
Measuring Market Power
Industry
7-15
Lerner Index
Markup Factor
Food
0.26
1.35
Tobacco
0.76
4.17
Textiles
0.21
1.27
Apparel
0.24
1.32
Paper
0.58
2.38
Chemicals
0.67
3.03
Petroleum
0.59
2.44
Overview of the Remainder of the Book

Perfect competition




Monopoly



Sole producer of good or service.
Market power (P > MC).
Monopolistic competition




Many, small firms and consumers relative to market.
Firms produce very similar products.
No market power (P = MC).
Many, small firms and consumers relative to market.
Firms produce slightly different products.
Limited market power.
Oligopoly


7-16
Few, large firms tend to dominate market.
Price/marketing strategies are mutually interdependent with other
firms in the industry.