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Industrial concentration
Industrial concentration refers to a structural
characteristic of the business sector. It is the
degree to which production in an industryor in
the economy as a wholeis dominated by a few
large firms. Once assumed to be a symptom of
market failure, concentration is, for the most
part, seen nowadays as an indicator of superior
economic performance.
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Concentration ratios
We have seen that the two polar extremes of market
structure are monopoly, with one firm, and perfect
competition, where there are many firms. Plus, we saw that
the perfect competition situation was more efficient in the
sense that total surplus for producers and consumers
together was maximized.
In the real world of business we see the number of firms
varies from industry to industry. In an attempt to find a
numerical measure to indicate which industries are more like
monopoly and which are more like competition,
concentration ratios were devised.
Concentration ratios typically use sales as the concept used
in the numerical measure.
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Concentration ratios
CRn is the sales added across the n largest firms in an
industry divided by the total industry sales(and then
multiply the result by 100 to be in percentage terms).
For example, CR4 is the sales of the 4 largest firms
added together divided by total sales in the industry.
Examples
a) Monopoly industry > CR4 = 100,
b) Industry with 4 firms of equal size (25% of sales for
each) -> CR4 = 100.
Can you tell which of the examples above has only one firm
by just looking at the CR4? Of course not!
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More examples:
c) 10 firms, each with 10% of market -> CR4 = 40,
d) 4 firms, each with 10%, and 30 firms, each with 2% ->
CR4 = 40.
Here we have two examples of industries where the CR4 is
the same. But we see the remaining firms after the top 4
are very different in each example. You would see this by
looking at the CR8, but not all the time. So, another
measure has been added and the measure considers all
the firms in an industry. The measure is the HHI

Herfindahl-Hirschman Index HHI

To get the HHI we need the market share of each firm in
percentage terms. Then we square the market share of each
firm. After this, simply add the squared market share of
each firm to get the final number.
Examples
a) Monopoly -> HHI = 1002 = 10,000. This is as big as you
can get.
b) 4 firms with 25% each -> HHI = 252 + 252 + 252 + 252 =
2500
c) 10 firms each with 10% -> HHI = 10 times 102 = 1000.
d) 4 firms with 10%, 30 firms with 2% -> HHI = 4 times 102
plus 30 times 22 = 400 + 120 = 520.
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HHI
The closer the HHI is to 10,000 the more the industry is like a
monopoly. The closer to 0 the more the industry is like a
competitive industry.
Issues with CR4 or HHI
The issue raised has to be settled before we can even calculate
the CR4 or the HHI.

The Census Bureau looks at firms that have similar production

processes and considers them to be in the same market. But, this
method may not be useful if consumers do not consider different
products with similar production processes to be substitutes for
each other.
The cross price elasticity of demand
The cross price elasticity of demand is defined as the percentage
change in the demand for good x given the percentage change in
the price of good y.
Example
If the price of Pepsi (and only Pepsi in this example) goes up we
would expect the demand for Coke to rise. So the cross price
elasticity of demand is positive for substitutes and we would
expect goods in the same market to have a high numerical value
for the cross price elasticity.
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Geography
Most studies have considered concentration ratios for the
country. Local ratios need to be considered.
If you look at the services of real estate agents, then
concentration ratios at the national level are probably small.
But, in many towns there is only one agent. Local ratios could
be large.
Ratios at the national level do not include foreign firms that
actually compete. This means that some industries will appear
more concentrated toward monopoly when, in fact, if you
include the foreign firms the ratios would be lower.

Vertical integration
Goods and services are the end of a process of transforming
inputs into those goods and services. Just think of a loaf of
bread. The wheat needed to be grown. Then the wheat is sent
on to millers. The miller sends on the stuff to the baker.
From the baker the item might go to a distributor and then the
retailer. The more that one firm is involved in all stages of the
production process, the more vertically integrated the firm is
said to be.
With this in mind, there are some industries that are not
vertically integrated and this would suggest low
concentration. But this could be misleading because all the
firms in the stream of production are tied to the main
product.
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The authors of our text use the example of Coke and Pepsi.
There are many bottlers around the country and this leads to low
concentration. But in the soft drink industry you and I know
Coke and Pepsi are the dominant players.
So, what have we done here? We listed numerical measures of
concentration designed to show what type of market structure an
industry might have. Plus, we indicated some ideas we need to
be aware of as we look at these measures.

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