Question

‏With an estimated market share of 60%, Atlas is the dominant company and the price leader in an oligopolistic steel industry. The remaining market share is distributed equally between ten companies. Suppose that one of those ten companies, Norton, attempts to gain market share by undercutting the price set by Atlas.

‏Calculate the “Four Firm Ratio” and Herfindahl-Hirschman Index “HHI” in the above described market and interpret your answer. What model can best resemble this market? Briefly explain this model. In your opinion, what will be the effect of Norton’s attempt described above on Atlas’s market share: will it increase, decrease, or not affected at all? Justify your answer.

Answer 1

Herfindahl-Hirschman Index “HHI” is measure of market concentration. It is calculated by squaring the market share of each firm competing in a market and then summing the resulting numbers.

Similarly, Four Firm Concentration ratio is also a measure of market concentration, but, it only accounts for the largest 4 firms and is a simple sum of their market shares.

According to the given situation, the market shares would be: 60% for Atlas, and 4% each for remaining 10 firms.

Thus, the HHI will be:

Generally, HHI above 2,500 is considered highly concentrated market. Thus, an HHI score of 3,760 points to the highly concentrated market share in the hands of Atlas, the largest company.

Similarly, 4FC or Four Firm Concentration is:

Thus, a high 4FC points to the fact that the market is almost leaning towards Oligopoly. Please note that 4FC can not differentiate between Oligopoly and Monopoly because the first firm may have the entire market share or the first four firms may share the entire market share. In both the cases, 4FC will show the same results.

The most representative model for this market structure is that of a Price Leadership Oligopolistic model. Price leadership occurs when a pre-eminent firm (the price leader) sets the price of goods or services in its market. This control can leave the leading firm's rivals with little choice but to follow its lead and match the prices if they are to hold on to their market share. Going further, we can specify Atlas as the "dominant" price leader i.e.one firm controls the vast majority of market share in its industry. The leading firm is flanked by small firms that provide the same products or services, but which cannot influence prices. The dominant leader in our case is "Atlas".

Now, Norton tries to capture Atlas' market share by cutting prices. If we assume that price cutting indeed gets Norton a larger market share, then, the market share for Norton will rise and that for Atlas for reduce. The magnitude can not be determined without adequate figures, but it can be safely assumed that HHI score will reduce. 4FC score will remain the same if the gain in Norton's market share is equal to the loss in Atlas' share.

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