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The four-firm concentration ratio

Regulators have struggled for decades to measure the degree of monopoly power in an industry. An early tool was the concentration ratio    , which measures what share of the total sales in the industry are accounted for by the largest firms, typically the top four to eight firms. For an explanation of how high market concentrations can create inefficiencies in an economy, refer to Monopoly .

Say that the market for replacing broken automobile windshields in a certain city has 18 firms with the market shares shown in [link] , where the market share    is each firm’s proportion of total sales in that market. The four-firm concentration ratio is calculated by adding the market shares of the four largest firms: in this case, 16 + 10 + 8 + 6 = 40. This concentration ratio would not be considered especially high, because the largest four firms have less than half the market.

Calculating concentration ratios from market shares
If the market shares in the market for replacing automobile windshields are:
Smooth as Glass Repair Company 16% of the market
The Auto Glass Doctor Company 10% of the market
Your Car Shield Company 8% of the market
Seven firms that each have 6% of the market 42% of the market, combined
Eight firms that each have 3% of the market 24% of the market, combined
Then the four-firm concentration ratio is 16 + 10 + 8 + 6 = 40.

The concentration ratio approach can help to clarify some of the fuzziness over deciding when a merger might affect competition. For instance, if two of the smallest firms in the hypothetical market for repairing automobile windshields merged, the four-firm concentration ratio would not change—which implies that there is not much worry that the degree of competition in the market has notably diminished. However, if the top two firms merged, then the four-firm concentration ratio would become 46 (that is, 26 + 8 + 6 + 6). While this concentration ratio is modestly higher, the four-firm concentration ratio would still be less than half, so such a proposed merger might barely raise an eyebrow among antitrust regulators.

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The herfindahl-hirshman index

A four-firm concentration ratio is a simple tool, which may reveal only part of the story. For example, consider two industries that both have a four-firm concentration ratio of 80. However, in one industry five firms each control 20% of the market, while in the other industry, the top firm holds 77% of the market and all the other firms have 1% each. Although the four-firm concentration ratios are identical, it would be reasonable to worry more about the extent of competition in the second case—where the largest firm is nearly a monopoly—than in the first.

Another approach to measuring industry concentration that can distinguish between these two cases is called the Herfindahl-Hirschman Index (HHI)    . The HHI, as it is often called, is calculated by summing the squares of the market share of each firm in the industry, as the following Work it Out shows.

Questions & Answers

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Capital can be defined as man made assets use in production .
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Two types of bank clearing house.
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dd: when price rises demand decreases whereas when price reduces dd rises ss: when ss rises the price rises and when ss decreases price also reduces. There is a positive relationship
Draw a demand curve graph
though price elasticity and elasticity are used interchangeably, the demand can respond to income changes and prices of related goods as well.
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Public goods are defined as products where, for any given output, consumption by additional consumers does not reduce the quantity consumed by existing consumers. Merit goods are, for example, education and to some extent the health-care. They are provided by state as "good for you".
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specialisation is a method of production whereby an entity focuses on the production of a limited scope of goods to gain a greater degree of efficiency.
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It is the control of market by single seller or producer
the exclusive possession or control of the supply or trade in a commodity or services
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apportunity cost means a goods which can be replace by other goods without any ease of saticfaction
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apportunity cost means the profit lose when one alternative is selected over other
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Economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.
It deals with making choices in the face of scarcity
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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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