Chapter 11: Problem 2

Is it true that the four-firm concentration ratio puts more emphasis on one or two very large firms, while the Herfindahl-Hirshman Index puts more emphasis on all the firms in the entire market? Explain briefly.

Short Answer

Expert verified

In conclusion, the four-firm concentration ratio emphasizes the largest firms, as it only considers the market shares of the top four firms. Conversely, the Herfindahl-Hirshman Index emphasizes all firms in the market, as it calculates market concentration by summing the squared market shares of all firms. Hence, the HHI provides a more comprehensive measure of market concentration, accounting for the presence of smaller firms and their impact on market competition, compared to the four-firm concentration ratio.

Step by step solution

Define Four-firm Concentration Ratio

The four-firm concentration ratio is a measure of market concentration that takes into account the market share of the four largest firms in an industry. It is calculated by adding the market shares of the four largest firms and expressing the sum as a percentage. A high concentration ratio suggests that the industry is dominated by a few large firms, while a low concentration ratio indicates more competitive market conditions.

Define Herfindahl-Hirshman Index (HHI)

The Herfindahl-Hirshman Index (HHI) is another measure of market concentration used to evaluate the competitiveness of an industry. It takes into account the market share of all the firms in the market and is calculated by summing the squares of the market shares of each firm, expressed as percentages. The HHI ranges from 0 to 10,000, with a higher value indicating a more concentrated or less competitive market, and a lower value implying a more competitive market with many small firms.

Compare the Emphasis on Large Firms

The four-firm concentration ratio puts more emphasis on the largest firms because it considers only the market shares of the top four firms. In a market with one or two very large firms, the four-firm concentration ratio would be high, signaling high market concentration. This means that the measure is sensitive to changes in the market shares of the largest firms and less considerate of the smaller firms in the market.

Compare the Emphasis on All the Firms in the Market

The Herfindahl-Hirshman Index, on the other hand, takes into consideration the market shares of all the firms in the market. It does this by squaring each firm's market share and then summing the squared shares to calculate the HHI. As a result, this measure emphasizes not only the largest firms but also accounts for the presence of all the firms in the market.

Conclusion

In conclusion, it is true that the four-firm concentration ratio puts more emphasis on one or two very large firms, while the Herfindahl-Hirshman Index places emphasis on all the firms in the entire market. The HHI provides a more comprehensive measure of market concentration, taking into account smaller firms and their impact on market competition, while the four-firm concentration ratio is more focused on the largest players in the market.