What is Market Concentration?
Market concentration refers to the degree of competitiveness within a specific market. In economics, market concentration is measured by the percentage of total market output or sales that is generated by a limited number of firms.
When few firms dominate a particular industry, such as Microsoft in the operating system software market, it is said that the industry has a high degree of concentration. Conversely, when there are many firms in a market and none of them have significant market share, the degree of market concentration is low.
What is the Herfindahl-Hirschman Index?
The Herfindahl-Hirschman Index, commonly referred to as the HHI, is a measure of market concentration that has been widely accepted by economists and government antitrust regulators. The HHI is derived by squaring the market share of each firm in the industry and then summing the resulting numbers.
The higher the HHI, the more concentrated the market is, meaning that a limited number of firms have a significant market share. Conversely, a low HHI indicates that the market is fragmented, with many firms having a relatively small market share each.
Why is the HHI important?
The HHI is an important tool used by economists and antitrust regulators to determine if a particular industry is concentrated enough to create concerns about competition. The US Department of Justice and the Federal Trade Commission, for example, have used the HHI to determine whether proposed mergers and acquisitions would result in an unacceptable level of market concentration.
Additionally, the HHI can be used to identify industries that may benefit from increased competition. If the HHI of a particular industry is relatively high, governments can consider policies that promote competition and break up market power among dominant firms.
Limitations of the HHI
While the HHI is a useful analytical tool, it has some limitations. Firstly, it does not provide information on the source of market concentration – that is, it does not indicate whether the market concentration is due to natural market forces or because of anti-competitive practices.
Secondly, the HHI does not take into consideration the degree of product differentiation. In some instances, the HHI may indicate high market concentration even when there are many firms within the industry because the products offered by these firms are extremely similar to each other. Conversely, in industries where products are significantly differentiated, the HHI may be low even when there are only a few firms dominating the market.
In summary, while the HHI is an effective measure of market concentration, it must be used in conjunction with other economic indicators to fully understand the level of competition within an industry.
