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In
economics Economics () is the social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics analyzes ...
, market concentration is a
function Function or functionality may refer to: Computing * Function key, a type of key on computer keyboards * Function model, a structured representation of processes in a system * Function object or functor or functionoid, a concept of object-oriente ...
of the number of firms and their respective shares of the total production (alternatively, total capacity or total reserves) in a
market Market is a term used to describe concepts such as: *Market (economics), system in which parties engage in transactions according to supply and demand *Market economy *Marketplace, a physical marketplace or public market Geography *Märket, an ...
. In any industry, a handful of firms that hold a significant portion of the market share and likely engage in the practice of consolidation will indicate higher market concentration within that industry. The market concentration ratio measures the concentration of the top firms in the market, this can be through various metrics such as sales, employment numbers, active users or other relevant indicators. In theory and in practice, market concentration is closely associated with market competitiveness, and therefore is important to various antitrust agencies when considering proposed mergers and other regulatory issues. Market concentration is important in determining firm
market power In economics, market power refers to the ability of a firm to influence the price at which it sells a product or service by manipulating either the supply or demand of the product or service to increase economic profit. In other words, market powe ...
in setting prices and quantities. Market concentration is affected through various forces, including barriers to entry and existing competition. Market concentration ratios also allows users to more accurately determine the type of
market structure Market structure, in economics, depicts how firms are differentiated and categorised based on the types of goods they sell (homogeneous/heterogeneous) and how their operations are affected by external factors and elements. Market structure makes it ...
they are observing, from a perfect competitive, to a monopolistic,
monopoly A monopoly (from Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none), as described by Irving Fisher, is a market with the "absence of competition", creating a situation where a speci ...
or
oligopolistic An oligopoly (from Greek ὀλίγος, ''oligos'' "few" and πωλεῖν, ''polein'' "to sell") is a market structure in which a market or industry is dominated by a small number of large sellers or producers. Oligopolies often result fro ...
market structure. Market concentration is related to industrial concentration, which concerns the distribution of production within an
industry Industry may refer to: Economics * Industry (economics), a generally categorized branch of economic activity * Industry (manufacturing), a specific branch of economic activity, typically in factories with machinery * The wider industrial sector ...
, as opposed to a market. In
industrial organization In economics, industrial organization is a field that builds on the theory of the firm by examining the structure of (and, therefore, the boundaries between) firms and markets. Industrial organization adds real-world complications to the perf ...
, market concentration may be used as a measure of
competition Competition is a rivalry where two or more parties strive for a common goal which cannot be shared: where one's gain is the other's loss (an example of which is a zero-sum game). Competition can arise between entities such as organisms, indiv ...
, theorized to be positively related to the rate of profit in the industry, for example in the work of Joe S. Bain. An alternative economic interpretation is that market concentration is a criterion that can be used to rank order various distributions of firms' shares of the total production (alternatively, total capacity or total reserves) in a
market Market is a term used to describe concepts such as: *Market (economics), system in which parties engage in transactions according to supply and demand *Market economy *Marketplace, a physical marketplace or public market Geography *Märket, an ...
.


Factors affecting Market Concentration

There are various factors that affect the concentration of specific markets which include; barriers to entry(high start-up costs, high
economies of scale In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, and are typically measured by the amount of output produced per unit of time. A decrease in cost per unit of output enables ...
, brand loyalty), industry size and age,
product differentiation In economics and marketing, product differentiation (or simply differentiation) is the process of distinguishing a product or service from others to make it more attractive to a particular target market. This involves differentiating it from co ...
and current advertising levels. There are also firm specific factors affecting market concentration, including: research and development levels, and the human capital requirements. Although fewer competitors doesn't always indicate high market concentration, it can be a strong indicator of the market structure and power allocation.


Metrics

After determining the relevant
market Market is a term used to describe concepts such as: *Market (economics), system in which parties engage in transactions according to supply and demand *Market economy *Marketplace, a physical marketplace or public market Geography *Märket, an ...
and firms, through defining the product and geographical parameters, various metrics can be employed to determine the market concentration. This can be quantified using the SSNIP test. A simple measure of market concentration is to calculate 1/N where N is the number of firms in the market. A result of 1 would indicate a pure monopoly, and will decrease with the number of active firms in the market, and nonincreasing in the degree of symmetry between them. This measure of concentration ignores the dispersion among the firms' shares. This measure is practically useful only if a sample of firms' market shares is believed to be
random In common usage, randomness is the apparent or actual lack of pattern or predictability in events. A random sequence of events, symbols or steps often has no order and does not follow an intelligible pattern or combination. Individual ra ...
, rather than determined by the firms' inherent characteristics. Any criterion that can be used to compare or
rank Rank is the relative position, value, worth, complexity, power, importance, authority, level, etc. of a person or object within a ranking, such as: Level or position in a hierarchical organization * Academic rank * Diplomatic rank * Hierarchy * ...
distributions (e.g. probability distribution,
frequency distribution In statistics, the frequency (or absolute frequency) of an event i is the number n_i of times the observation has occurred/recorded in an experiment or study. These frequencies are often depicted graphically or in tabular form. Types The cumula ...
or size distribution) can be used as a market concentration criterion. Examples are stochastic dominance and Gini coefficient.


Herfindahl–Hirschman Index

The most commonly used market concentration measure is the Herfindahl–Hirschman Index (HHI or H). H=\sum_^N s_i^2 Where s_i is the market share of firm i, conventionally expressed as a percentage, and N is the number of firms in the relevant market. HHI can range from 10000/N to 10000. In most markets, an HHI below 1500 indicates a market with low concentration. An HHI of 5000 indicates a market where one firm has at least 50% market share, and an HHI of 10000 indicates a fully monopolised market. If market shares are expressed as decimals, an HHI of 0 represents a perfectly competitive industry while an HHI index of 1 represents a monopolised industry. Regardless whether the decimal or percentage HHI is used, a higher HHI indicates higher concentration within a market. Section 1 of the
Department of Justice A justice ministry, ministry of justice, or department of justice is a ministry or other government agency in charge of the administration of justice. The ministry or department is often headed by a minister of justice (minister for justice in a ...
and the Federal Trade Commission's '' Horizontal Merger Guidelines'' is entitled "Market Definition, Measurement and Concentration" and states that the Herfindahl index is the measure of concentration that these Guidelines will use.


Concentration Ratio

Another common measure is the
concentration ratio In economics, concentration ratios are used to quantify market concentration and are based on companies' market shares in a given industry. Market share can be defined as a firm's proportion of total sales in an industry, a firm's market capita ...
(CR). This ratio simply measures the concentration of the largest firms in the form CR_n = C_1+C_2+.....+C_n where N is usually between 3 and 5. Although CR can provide a quick insight into the overall market concentration, it is limited in providing an accurate representation of industry competition, as this ratio does not provide a measure for the concentration within the top n, as a merger between two firms would not increase the overall CR, but would increase overall market concentration using other measures. As a rule of thumb, when using n=5 anything over 0.6 or 60% is considered an oligopoly, whereas when N=5, anything under 0.5 or 50% can be considered competitive and lowly concentrated.


Regulatory Usage


Historical Usage

Since the introduction of the
Sherman Antitrust Act of 1890 The Sherman Antitrust Act of 1890 (, ) is a United States antitrust law which prescribes the rule of free competition among those engaged in commerce. It was passed by Congress and is named for Senator John Sherman, its principal author. T ...
, in response to growing monopolies and anti-competitive firms in the 1880s, antitrust agencies regularly use market concentration as an important metric to evaluate potential violations of competition laws. Since the passing of the act, these metrics have also been used to evaluate potential mergers' effect on overall market competition and overall
consumer welfare Welfare economics is a branch of economics that uses microeconomic techniques to evaluate well-being (welfare) at the aggregate (economy-wide) level. Attempting to apply the principles of welfare economics gives rise to the field of public econ ...
. The first major example of the Sherman Act being imposed on a company to prevent potential consumer abuse through excessive market concentration was in the 1911 court case of '' Standard Oil Co. of New Jersey v. United States'' where after determining Standard Oil was monopolising the petroleum industry, the court-ordered remedy was the breakup into 34 smaller companies.


Modern Usage

Modern regulatory bodies state that an increase in market concentration can inhibit innovation, and have detrimental effects on overall consumer welfare. The
United States Department of Justice The United States Department of Justice (DOJ), also known as the Justice Department, is a federal executive department of the United States government tasked with the enforcement of federal law and administration of justice in the United Stat ...
determined that any merger that increases the HHI by more than 200 proposes a legitimate concern to antitrust laws and consumer welfare . Therefore, when considering potential mergers, especially in
horizontal integration Horizontal integration is the process of a company increasing production of goods or services at the same part of the supply chain. A company may do this via internal expansion, acquisition or merger. The process can lead to monopoly if a c ...
applications, antitrust agencies will consider the whether the increase in efficiency is worth the potential decrease in consumer welfare, through increased costs or reduction in quantity produced. Whereas the
European Commission The European Commission (EC) is the executive of the European Union (EU). It operates as a cabinet government, with 27 members of the Commission (informally known as "Commissioners") headed by a President. It includes an administrative body ...
is unlikely to contest any
horizontal integration Horizontal integration is the process of a company increasing production of goods or services at the same part of the supply chain. A company may do this via internal expansion, acquisition or merger. The process can lead to monopoly if a c ...
, which post merger HHI is under 2000 (except in special circumstances). Modern examples of market concentration being utilised to protect consumer welfare include: * 2014 Attempted purchase of Time Warner Cable by Comcast, was abandoned after the
US DOJ The United States Department of Justice (DOJ), also known as the Justice Department, is a federal executive department of the United States government tasked with the enforcement of federal law and administration of justice in the United State ...
threatened to file an antitrust lawsuit, citing that the HHI of the national television industry would increase by 639 points to a HHI of 2454, and feared this merger would lead to increased prices for consumers. *
Halliburton Halliburton Company is an American multinational corporation responsible for most of the world's hydraulic fracturing operations. In 2009, it was the world's second largest oil field service company. It has operations in more than 70 countries ...
and Baker Hughes (at the time the 2nd and 3rd largest
oilfield services This is a list of oilfield service companies – notable companies that provide services to the petroleum exploration and production industry but do not typically produce petroleum. In the list, notable subsidiary companies and divisions are listed ...
companies, respectively) attempted 2014 merger was blocked by the US DOJ, after fears that the merger would increase costs for oil companies in 23 separate product markets, and therefore would stiffen innovation in the oil sector. *
General Electric General Electric Company (GE) is an American multinational conglomerate founded in 1892, and incorporated in New York state and headquartered in Boston. The company operated in sectors including healthcare, aviation, power, renewable en ...
's attempted acquisition of
Honeywell Honeywell International Inc. is an American publicly traded, multinational conglomerate corporation headquartered in Charlotte, North Carolina. It primarily operates in four areas of business: aerospace, building technologies, performance ma ...
in 2001, was approved in the United States, however the condition's that European Commission enforced for the approval were too impactful for General Electric, and was abandoned. This is an example on how different regulatory bodies view mergers.


Motivation for Firms

The relationship between market concentration and profitability can be divided into two arguments: greater market concentration increases the likelihood of collusion between firms which, resulting in higher pricing. In contrast, market concentration occurs as a result of the efficiency obtained in the course of being a large firm, which is more profitable in comparison to smaller firms and their lack of efficiency.


Collusion

There are game theoretic models of market interaction (e.g. among
oligopolists An oligopoly (from Greek ὀλίγος, ''oligos'' "few" and πωλεῖν, ''polein'' "to sell") is a market structure in which a market or industry is dominated by a small number of large sellers or producers. Oligopolies often result from ...
) that predict that an increase in market concentration will result in higher prices and lower
consumer welfare Welfare economics is a branch of economics that uses microeconomic techniques to evaluate well-being (welfare) at the aggregate (economy-wide) level. Attempting to apply the principles of welfare economics gives rise to the field of public econ ...
even when
collusion Collusion is a deceitful agreement or secret cooperation between two or more parties to limit open competition by deceiving, misleading or defrauding others of their legal right. Collusion is not always considered illegal. It can be used to att ...
in the sense of
cartel A cartel is a group of independent market participants who collude with each other in order to improve their profits and dominate the market. Cartels are usually associations in the same sphere of business, and thus an alliance of rivals. Mos ...
ization (i.e. explicit collusion) is absent. Examples are '' Cournot oligopoly'', and '' Bertrand oligopoly for differentiated products''. Bain's (1956) original concern with market concentration was based on an intuitive relationship between high concentration and collusion which led to Bain's finding that firms in concentrated markets should be earning supra-competitive profits. Collins and Preston (1969) shared a similar view to Bain with focus on the reduced competitive impact of smaller firms upon larger firms. Demsetz held an alternative view where he found a positive relationship between the margins of specifically the largest firms within a concentrated industry and collusion as to pricing. Although theoretical models predict a strong correlation between market concentration and collusion, there is little empirical evidence linking market concentration to the level of collusion in an industry. In the scenario of a merger, some studies have also shown that the asymmetric market structure produced by a merger will negatively affect collusion despite the increased concentration of the market that occurs post-merger.


Efficiency

As an economic tool market concentration is useful because it reflects the degree of competition in the market. Understanding the market concentration is important for firms when deciding their marketing strategy. As well, empirical evidence shows that there exists an inverse relationship between market concentration and efficiency, such that firms display an increase in efficiency when their relevant market concentration decreases. The above positions of Bain (1956) as well as Collins and Preston (1969) are not only supportive of collusion but also of the efficiency-profitability hypothesis: profits are higher for bigger firms within a greater concentrated market as this concentration signifies greater efficiency through mass production. In particular, economies of scale was the greatest kind of efficiency that large firms could achieve in influencing their costs, granting them greater market share. Notably however, Rosenbaum (1994) observed that most studies assumed the relationship between actual market share and observed profitability by following the implication that large firms hold greater market share due to their efficiency, demonstrating that the relationship between these efficiency and market share is not clearly defined.


Industry Effects


Innovation

Schumpeter Joseph Alois Schumpeter (; February 8, 1883 – January 8, 1950) was an Austrian-born political economist. He served briefly as Finance Minister of German-Austria in 1919. In 1932, he emigrated to the United States to become a professor at Ha ...
(1950) first recognised the relationship between market concentration and innovation in that a higher concentrated market would facilitate innovation. He reasoned that firms with the greatest market share have the greatest opportunity to benefit from their innovations, particularly through investment into R&D. This can be contrasted with the position taken by Arrow (1962) that a greater market concentration will decrease incentive to innovate because a firm within a monopoly or monopolistic market would have already reached profit levels that greatly exceed costs. In practice, there are complications in observing the direct correlation between market concentration and its effect on. In collecting empirical evidence, issues have also arisen as to how innovation, a firm's control and gaps between R&D and firm size are measured. There has also been a lack of consensus. For example, a negative correlation was established by Connelly and Hirschey (1984) who explained that the correlation evidenced a decreased expenditure on R&D by oligopolistic firms to benefit from greater monopolised profits. However, Blundell et al. observed a positive correlation by tallying the patents lodged by firms. This general observation was also shared by Aghion et al. in 2005. Schumpeter also failed to distinguish between the different technologies that contribute to innovation and did not properly define “creative destruction”. Petit and Teece (2021) argued that technological opportunities, a variable which Schumpeter and Arrow did not include during their time, would be included in this definition as it enables new entrants to make a “breakthrough” into the industry. Research presented by Aghion et al. (2005) suggested an inverted U-shape model that represents the relationship between market concentration and innovation. Delbono and Lambertini modelled empirical evidence onto a graph and found that the pattern demonstrated by the data supported the existence of a U-shaped relationship between these two variables.


Alternative Metrics

Although, not as common as the Herfindahl–Hirschman Index or Concentration Ratio metrics, various alternative measures of market concentration can also be used. (a) The U Index (Davies, 1980): :U = I^N^ where I^ is an accepted measure of inequality (in practice the coefficient of variation is suggested), a is a constant or a parameter (to be estimated empirically) and N is the number of firms. Davies (1979) suggests that a concentration index should in general depend on both N and the inequality of firms' shares. :The "number of effective competitors" is the inverse of the Herfindahl index. :Terrence Kavyu Muthoka defines distribution just as functionals in the Swartz space which is the space of functions with compact support and with all derivatives existing. The Media:Dirac Distribution or the Dirac function is a good example. (b) The Linda index (1976) :L=\frac 1 \sum_^Q_i\left \frac \right left \vert \frac \right \vert :where ''Qi'' is the ratio between the average share of the first i firms and the average share of the remaining N - i firms and CR_i is the concentration coefficient for the first i firms. Although it doesnt capture the peripheral firms like the HHI formula, it works to capture the "core" of the market, and masure the degree of inequality between the size variable accounted for by various sib-samples of firms. This index, does assume pre-calculation on the users' behalf to determine the relevant value of CR_i However, there is little empirical evidence of regulatory usage of the Linda Index. (c) Comprehensive concentration index (Horwath 1970): :CCI = s_1 + \sum_^N s_i^2(2 - s_i) :Where s1 is the share of the largest firm. The index is similar to 2\text - \sum s_i^3 except that greater weight is assigned to the share of the largest firm. When compared to the HHI index, it does present some advantages, such as giving more weight to the quantity of small firms, however the arbitrary choice to only include the absolute value of one firm has led to criticism over its accuracy and usefulness. (d) The Rosenbluth (1961) index (also Hall and Tideman, 1967): :R = \frac where symbol ''i'' indicates the firm's rank position. :The Rosenbluth index assigns more weight to smaller competitors when there are more firms present in the marketplace, and is sensitive to the amount of competitors in the market, even if there is a small amount of large firms dominating. Its coefficients and ranking are similar to results produced through the use of the Herfindahl-Hirschman Index. (e) The Gini coefficient (1912) :G = 1 - \sum_^N S_i\frac :The Gini coefficient measures the difference between firms' sizes without including the number of firms operating in a market. This is known as a relative concentration measure and differs from absolute concentration measures (like the Rosenbluth index) which includes the number of firms and firms' distribution sizes. It is used in conjunction with the Lorenz curve. Originally, the Lorenz curve measured the inequality of income distributed with a population and ranked individuals from highest to lowest earnings. Therefore, in this context the Gini coefficient is located between the 45° line representing an equal distribution of income and the Lorenz curve representing the actual distribution of income within the population. In a market concentration context, the Lorenz curve can be plotted ranking firms' market shares from smallest to largest to simulate a concentration curve. The firms’ cumulative percentage shares would remain on the y axis and the cumulative percentage of sellers would remain on the x axis. \frac would the sum of weighted market share located in the area above the concentration curve. The Gini coefficient is 0 when the concentration curve aligns with the 45° line representing a single firm's market share, meaning the market is a monopoly.


See also

*
Concentration ratio In economics, concentration ratios are used to quantify market concentration and are based on companies' market shares in a given industry. Market share can be defined as a firm's proportion of total sales in an industry, a firm's market capita ...
* Dominance (economics) * Gini coefficient * Herfindahl index * Horizontal Merger Guidelines * Lorenz curve * Inequality of wealth *
Market failure In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value. Market failures can be viewed as scenarios where indi ...
*
Monopoly A monopoly (from Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none), as described by Irving Fisher, is a market with the "absence of competition", creating a situation where a speci ...
* Probability distribution * Stochastic dominance * Relative market share


References

* Bain, J. (1956). ''Barriers to New Competition.'' Cambridge, Massachusetts: Harvard Univ. Press. * Curry, B. and K. D. George (1983). "Industrial concentration: A survey" ''Jour. of Indust. Econ.'' 31(3): 203–55 * * Tirole, J. (1988). ''The Theory of Industrial Organization.'' Cambridge, Massachusetts: MIT Press. * Weiss, L. W. (1989). ''Concentration and price.'' Cambridge, Massachusetts : MIT Press.


External links


Department of Justice and Federal Trade Commission Horizontal Merger Guidelines
{{instecon Concentration indicators Imperfect competition Market structure Monopoly (economics)