Market Concentration: Definition and Overview

Market Concentration: A measure of the extent to which a small number of firms dominate the total sales in a market.

Market concentration is a measure of the extent to which a small number of firms dominate the total sales or production within a given market. It indicates the level of control that a firm or a group of firms has over the market and reflects the degree of competition among firms in that sector. High market concentration often suggests less competitive markets, while low market concentration indicates more competition.

Calculating Market Concentration

Herfindahl-Hirschman Index (HHI)

The Herfindahl-Hirschman Index (HHI) is a commonly used measure of market concentration. It is calculated by summing the squares of the market shares of all firms in the market:

$$ HHI = \sum_{i=1}^{n} s_i^2 $$

where \( s_i \) is the market share of firm \( i \), expressed as a percentage, and \( n \) is the total number of firms.

Concentration Ratios (CR)

Another way to measure market concentration is through concentration ratios (CR), which indicate the market share of the largest firms in the market. The \( k \)-firm concentration ratio (CR\( k \)) is defined as:

$$ CR_k = \sum_{i=1}^{k} s_i $$

where \( k \) is the number of the largest firms considered, often the top 4 or 8 firms.

Types and Examples

High Market Concentration

An industry with high market concentration might be dominated by a few large firms. For example, the aerospace industry is highly concentrated, with companies like Boeing and Airbus dominating the market.

Moderate Market Concentration

Industries with moderate concentration have a balanced distribution of market share among several firms. For instance, the fast-food industry in many countries exhibits moderate concentration.

Low Market Concentration

Low market concentration indicates a fragmented market with many small firms, often seen in sectors like local retail markets or specialty boutiques.

Historical Context

Market concentration has evolved over time, especially with the rise of globalization and technological advancements. The antitrust laws, formulated in the late 19th and early 20th centuries, aimed to combat excessive concentration and promote competition. Post World War II saw varied levels of concentration across different industries, influenced by mergers, acquisitions, and regulatory changes.

Applicability

Market concentration is relevant to policymakers, regulatory bodies, and firms for understanding market dynamics and competitive behavior. It helps in assessing the potential for monopolistic practices and informs decisions on mergers and acquisitions.

Comparisons

• Market Power vs. Market Concentration: Market power refers to a firm’s ability to influence prices and output levels, whereas market concentration measures the distribution of market share among firms.
• Perfect Competition vs. Monopolistic Competition: In perfect competition, numerous small firms compete, resulting in low concentration. In monopolistic competition, market concentration depends on brand differentiation and market niches.

Related Terms

• Market Power: The ability of a firm to influence the price of an item in the market.
• Oligopoly: A market structure characterized by a small number of firms whose decisions affect each other.
• Monopoly: A market structure where one firm dominates the market.

FAQs

Why is market concentration important?

It helps to identify the competitive landscape of an industry, which is crucial for regulatory bodies to prevent monopolistic practices and ensure fair competition.

How does market concentration affect consumers?

High market concentration can lead to higher prices and reduced choices for consumers, whereas low concentration often results in competitive pricing and more options.

Can market concentration change over time?

Yes, market concentration can change due to mergers, acquisitions, technological innovations, and changes in consumer preferences.

References

1. U.S. Department of Justice. “Herfindahl-Hirschman Index.”
2. Besanko, D., Dranove, D., Shanley, M., & Schaefer, S. (2017). “Economics of Strategy.”
3. Bain, J.S. (1951). “Relation of profit rate to industry concentration: American manufacturing, 1936–1940.”

Summary

Market concentration measures the extent to which a small number of firms control a market, reflecting the competitive dynamics within an industry. Higher market concentration often signals less competition and potential for monopolistic behaviors, whereas lower concentration denotes a more competitive market. Various indices like HHI and CR are utilized to gauge market concentration, providing critical insights for policymakers, economists, and industry stakeholders.