Question

Give two advantages of the Herfindahl index over the concentration ratio. Explain why you picked the two items you picked.

Answer 1

The concentration ratio cannot be used when there are many firms in the market. This is because this measure gives us the market share of only top four firms. Market share of rest of the forms are not included which results gives us an inconclusive picture of the market. In contrast, herfindahl index uses the market share of all the operating firms in the market. This indicates that the resultant value will be a representation of the entire market

Secondly, it is not a good measure of market concentration. It just provides the market share of top four firms irrespective of their market shares. It may be possible that for concentration ratio of 80%, one of the firm as a market share of 70% while the remaining 3 have a combined share of 10%. This problem is eliminated by the herfindahl index because this index specifically indicates the conservation of market by including all the market shares.