Question

1. You are given the table below which contains sales figures for three industries.

Firm                Industry1        Industry2        Industry3

A                     $450                $800                $200

B                     $200                $50                  $200

C                     $150                $25                  $200

D                     $100                $25                  $200

E                     $50                  $20                  $200

All Others       5X$10            2X$40             $0

Figures in millions of current dollars.

Note that, 5X$10 in all others category for Industry 1 means 5 firms each having 10 (millions of) dollars sales figures. All others category in Industry2 should be similarly interpreted

a) Compute the 4-firm concentration ration (C4) for each industry. What does this index have to say about which industry is most concentrated?

b) Compute the Herfindahl-Hirschman Index (HHI) for each industry. What does this index have to say about which industry is most concentrated?

c) Why do you think the HHI does a better job than C4 of measuring industry concentration? Give two reasons for your answer and illustrate each one by reference to the above table.

d) In the end, which industry would you describe as the most concentrated?

Answer 1

Firm	Industry 1	Industry 2	Industry 3
A	$450 (45%)	$800 (80%)	$200 (20%)
B	$200 (20%)	$50 (5%)	$200 (20%)
C	$150 (15%)	$25 (2.5%)	$200 (20%)
D	$100 (10%)	$25 (2.5%)	$200 (20%)
E	$50 (5%)	$20 (2%)	$200 (20%)
All others	5 X $10=$ 50 (5%)	2 X $40 =$80 (8%)	$0
Total	$1000	$1000	$1000

Note: The market share of the firms in the industry is given in ( ).

Market share of firm in industry is calculated as follows:

Market Share =  

a)

The four firm concentration ratio is the summation of the total sales of the top four firms divided by the total sales of the industry.

INDUSTRY 1

The top four firms (A,B,C,D) account for $900 of total sales in Industry 1.

Four firm concentration ratio:

INDUSTRY 2

The top four firms (A,B, All others) account for $930 of total sales in Industry 1. The category “all others” includes two firms with $40 million sales each.

Four firm concentration ratio:  

INDUSTRY 3

In Industry 3, all the five firms have equal number of sales ($20 million each). Thus, we consider any four from the five firms to calculate the concentration ratio.

Four firm concentration ratio:  

Concentration ratio above 80% indicates that the industry is highly concentrated. Among the three industries, Industry 2 has the highest concentration.

b)

Herfindahl-Hirschman Index is a measure to indicate the market concentration of firms in an industry. The Herfindahl Index is calculated by the summation of squares of the market share of firms in the Industry.

The firms under “all others” are taken as a single firm.

INDUSTRY 1

The Herfindahl-Hirschman Index is as follows:

HHI= 452+202+152+102+52+52= 2800

The HHI indicates that Industry 1 is highly concentrated as it is above 2500 points.

INDUSTRY 2

The Herfindahl-Hirschman Index is as follows:

HHI= 802+52+2.52+2.52+22+82= 6501.5

The HHI indicates that Industry 2 is highly concentrated.

INDUSTRY 3

The Herfindahl-Hirschman Index is as follows:

HHI= 202+202+202+202+202= 2000

The HHI indicates that Industry 3 has medium concentration as it lies below 2500 points.

c)

(i) The Herfindahl-Hirschman Index considers all the firms in the industry, while the C4 ratio considers only the market share of the top four firms in the industry.

(ii) The Herfindahl-Hirschman Index gives more weight to the large firms in the industry.

d)

Based on the four-firm concentration ratio and Herfindahl-Hirschman Index, Industry 2 has the highest concentration.