Suppose the two industries exhibit the following market shar

Suppose the two industries exhibit the following market shares for firms:

                  Industry A                   Industry B

Firm 1         26%                            25%

Firm 2         23%                            23%

Firm 3        22%                             22%

Firm 4        10%                             17%

Firm 5        7%                               13%

Firm 6        5%

Firm 7         3%

Firm 8         2%

Firm 9         1%

Firm 10       1%

a. Calculate the three firm concentration ratio and interpret

b. Calculate the Herfindahl Index and interpret

c. Which industry is the most competitive? Explain.          

Solution

In economics, a concentration ratio is a measure of the total output produced in an industry by a given number of firms in the industry. The most common concentration ratios are the CR₄ and the CR₈, which means the market share of the four and the eight largest firms.

Three firm concentration ratio for indutry A is 26+23+22 = 71%

Three firm concentration ratio for indutry B is 25+23+22 = 70%

Concentration ratio is high in indtry A but there is a maginal difference.

b. Another measure of concentration in an industry can be expressed using the Herfindahl index. The Herfindahl index is simply the sum of the squares of the market shares for each firm within the industry and is always less than one.

Industry A = (0.26)²+(0.23)²+(0.22)² = 0.0676+0.0529+0.0484 = 0.1689

IndustryB = (0.25)²+(0.23)²+(0.22)² = 0.0625+0.0529+0.0484 = 0.1638

c) Industry B is more competitive as its Harfindahl index is lower.