Market Structure
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
Market Structure
Measuring Industry Concentration
– Four-firm concentration ratio:
𝑆𝑆1 + 𝑆𝑆2 + 𝑆𝑆3 + 𝑆𝑆4
𝐶𝐶𝑅𝑅4 =
𝑆𝑆𝑇𝑇
• 𝑆𝑆1 , 𝑆𝑆2 , 𝑆𝑆3 and 𝑆𝑆4 denote the sales of the four
largest firms in an industry
• 𝑆𝑆𝑇𝑇 denotes the total sales of all firms in the
industry
7-3
Measuring Industry Concetration
𝐶𝐶𝑅𝑅4 =𝑤𝑤1 +𝑤𝑤2 +𝑤𝑤3 +𝑤𝑤4
• 𝑤𝑤𝑖𝑖 : market share of firm i
• The ration is the sum of the market shares
of the top four firms
Market Structure
Measuring Industry Concentration 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 𝑆𝑆𝑇𝑇 = $50.
– Sales of the four largest firms are $40.
– The four-firm concentration ratio
$10+$10+$10+$10
is: 𝐶𝐶4 =
=
0.80
$50
– The four largest firms in the industry account for 80
percent of total industry output.
7-5
Measuring Industry Concentration
Problem:
EX1: 𝐶𝐶𝑅𝑅4 =(0.97, 0.01, 0.01, 0.01)
EX2: 𝐶𝐶𝑅𝑅4 =(0.25,0.25,0.25,0.25)
7-6
Market Structure
Measuring Industry Concentration
Herfindahl-Hirschman index (HHI):
𝑁𝑁
𝑆𝑆𝑖𝑖
𝐻𝐻𝐻𝐻𝐻𝐻 = 10,000 �
𝑆𝑆𝑇𝑇
2
𝑖𝑖=1
– 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
7-7
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
7-8
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
7-9
Measuring Market Power
• Lerner index
– A measure of the difference between price and
marginal cost as a fraction of the product’s price.
𝑃𝑃 − 𝑀𝑀𝑀𝑀
𝐿𝐿 =
𝑃𝑃
rearranging this equation yields
1
𝑃𝑃 =
𝑀𝑀𝐶𝐶
1 − 𝐿𝐿
, where
costs.
1
1−𝐿𝐿
is the markup factor over marginal
7-10
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
𝑃𝑃 − 𝑀𝑀𝑀𝑀 $300 − $200 1
𝐿𝐿 =
=
=
𝑃𝑃
$300
3
• The markup factor is
1
1
=
= 1.5
1 − 𝐿𝐿 1 − 1
3
• For each $1 paid to a firm in the airline industry, 33
cents is markup
7-11
Measuring Market Power
Industry
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
Conduct
7-12
Overview of the Remainder of the Book
Looking Ahead
• Perfect competition
– Many, small firms and consumers relative to market.
– Firms produce very similar products.
– No market power (P = MC).
• Monopoly
– Sole producer of good or service.
– Market power (P > MC).
• Monopolistic competition
– Many, small firms and consumers relative to market.
– Firms produce slightly different products.
– Limited market power.
• Oligopoly
– Few, large firms tend to dominate market.
– Price/marketing strategies are mutually interdependent with
other firms in the industry.
7-13