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Problem 11.1 - Measures of industry concentration

Problem:

Suppose that the 6 firms in an industry have total annual sales of $70 billion, $40 billion, $30 billion, $30 billion, $20 billion, and $10 billion.

  1. What is the four-firm concentration ratio in this industry?
  2. What is the Herfindahl index for this industry?
  3. Suppose another industry has a Herfindahl index of 4000. What can you conclude about the relative competitiveness of these two industries?

Answer:

  1. The four-firm concentration ratio is the ratio of the sales of the four largest firms in the industry relative to total industry sales, expressed as a percentage. In this industry, total sales are $200 billion and the top four combined have sales of $170 billion. The four-firm concentration ratio is then 170/200 = .85, or 85%.
  2. The Herfindahl index is computed as the sum of the squared market shares for all firms in the industry. In this example, the 6 firms have market shares of 35%, 20%, 15%, 15%, $10%, and 5%. The index is 352 + 202 + 152 + 152 + 102 + 52 = 2200.
  3. Larger index numbers correspond to more highly concentrated industries. Accordingly, firms in the second industry are likely to have more market power.







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