Concentration ratio
Encyclopedia
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 four and the eight largest firms. Concentration ratios are usually used to show the extent of market control of the largest firms in the industry and to illustrate the degree to which an industry is oligopolistic.
The standard tools of competition economists and competition authorities to measure market concentration are the Herfindahl index
(HHI) and the concentration ratios (CR(n)). These two are known as the traditional structural measures of market concentration (based on market shares). The concentration of firms in an industry is of interest to economists, business strategists and government agencies.
Usually, these two common ratios are comparable from industry to industry, while concentration ratios for other numbers of firms can be also calculated.
CRm= Σmi=1 si
Therefore it can be expressed as:
CRm = s1 + s2 + .... + sm
where si is the market share and m defines the ith firm
No concentration: 0% means perfect competition
or at the very least monopolistic competition
. If for example CR4=0 %, the four largest firm in the industry would not have any significant market share.
Total concentration: 100% means an extremely concentrated oligopoly
. If for example CR1= 100%, there is a monopoly
.
Low concentration: 0% to 50%. This category ranges from perfect competition to oligopoly.
Medium concentration: 50% to 80%. An industry in this range is likely an oligopoly.
High concentration: 80% to 100%. This category ranges from oligopoly to monopoly.
The Herfindahl index
provides a more complete picture of industry concentration than does the concentration ratio.
UK industries with the lowest five-firm concentration ratios include the following:
The Pivotal Supplier Index is expressed as the following:
PSI = I[Cx > Σni=I Ci - Total Consumption]
where Cx is the capacity of the potential pivotal supplier and the sum of Ci the capacity of all suppliers.
The function I[.] is the indicator function, which takes the value 1 if the expression "." contained in it is true.
An equivalent expression is the following:
PSI = I[Total consumption > Σi≠xCi ]
where the sum of capacities is taken over all suppliers apart from x.
The PSI is a binary indicator that can be calculated hourly. If the supplier Cx is needed to supply the demand, it is pivotal and the index takes the value "1". If he is not pivotal, it takes the value "0".
The Residual Supply Index is expressed as:
RSI = (Σn1 Ci - Cx)/Last
where Cx is the capacity of the analysed supplier and the sum of Ci the capacity of all suppliers.
Receiving a result bigger than 100% is an indication that the supplier x should have little influence on the price. With a RSI smaller than 100%. the supplier x could easily practise market power. The RSI has the advantage over the PSI to be not binary and for this reason he can better indicate the increase of the structural market power.
The standard tools of competition economists and competition authorities to measure market concentration are the Herfindahl index
Herfindahl index
The Herfindahl index is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them. Named after economists Orris C. Herfindahl and Albert O. Hirschman, it is an economic concept widely applied in competition law, antitrust and also...
(HHI) and the concentration ratios (CR(n)). These two are known as the traditional structural measures of market concentration (based on market shares). The concentration of firms in an industry is of interest to economists, business strategists and government agencies.
Two common ratios
- The Four-Firm Concentration Ratio measures the total market shareMarket shareMarket share is the percentage of a market accounted for by a specific entity. In a survey of nearly 200 senior marketing managers, 67 percent responded that they found the "dollar market share" metric very useful, while 61% found "unit market share" very useful.Marketers need to be able to...
of the four largest firms in an industry. - The Eight-Firm Concentration Ratio measures the total market share of the eight largest firms in an industry.
Usually, these two common ratios are comparable from industry to industry, while concentration ratios for other numbers of firms can be also calculated.
Calculation
The concentration ratio is the percentage of market share held by the largest firms (m) in an industry.CRm= Σmi=1 si
Therefore it can be expressed as:
CRm = s1 + s2 + .... + sm
where si is the market share and m defines the ith firm
Concentration levels
Concentration ratios range from 0 to 100 percent. The levels reach from no, total, low or medium to high concentration.No concentration: 0% means perfect competition
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...
or at the very least monopolistic competition
Monopolistic competition
Monopolistic competition is imperfect competition where many competing producers sell products that are differentiated from one another...
. If for example CR4=0 %, the four largest firm in the industry would not have any significant market share.
Total concentration: 100% means an extremely concentrated oligopoly
Oligopoly
An oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι "few" + πόλειν "to sell". Because there are few sellers, each oligopolist is likely to be aware of the actions of the others...
. If for example CR1= 100%, there is a monopoly
Monopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
.
Low concentration: 0% to 50%. This category ranges from perfect competition to oligopoly.
Medium concentration: 50% to 80%. An industry in this range is likely an oligopoly.
High concentration: 80% to 100%. This category ranges from oligopoly to monopoly.
Problems
The definition of the concentration ratio does not use the market shares of all the firms in the industry and does not provide the distribution of firm size. It also does not provide a lot of detail about competitiveness of the industry. The concentration ratios just provide a sign of the oligopolistic nature of an industry and indicate the degree of competition.The Herfindahl index
Herfindahl index
The Herfindahl index is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them. Named after economists Orris C. Herfindahl and Albert O. Hirschman, it is an economic concept widely applied in competition law, antitrust and also...
provides a more complete picture of industry concentration than does the concentration ratio.
Concentration ratios in United Kingdom
UK industries with the highest five-firm concentration ratios include the following:- Sugar: 99%
- Tobacco products: 99%
- Gas distribution: 82%
- Oils and fats: 88%
- Confectionery: 81%
- Man-made fibres: 79%
- Coal extraction: 79%
- Soft drinks and mineral waters: 75%
- Pesticides: 75%
- Weapons and ammunition: 77%
UK industries with the lowest five-firm concentration ratios include the following:
- Metal forging, pressing etc.: 4%
- Plastic products: 4%
- Furniture: 5%
- Construction: 5%
- Structural metal products: 6%
- Wholesale distribution: 6%
- General purpose machinery: 8%
- Wood and wood products: 9%
Electricity specific measures
As to account for the specificities of electricity markets the specific structural measures are calculated. The Herfindahl index and the concentration ratios focus on the market shares of companies, but these measures identify the “pivotalness” of companies to meeting the demand on the system. A company that is very pivotal can be said to have a high market power.Pivotal Supplier Index (PSI)
The Pivotal Supplier Index considers in addition to the supply side the demand. At the most basic level, the PSI answers the question if a particular supplier, the "pivotal supplier", is needed to supply the demand: would it be possible to supply the electricity demand also without this supplier or is he mandatory?The Pivotal Supplier Index is expressed as the following:
PSI = I[Cx > Σni=I Ci - Total Consumption]
where Cx is the capacity of the potential pivotal supplier and the sum of Ci the capacity of all suppliers.
The function I[.] is the indicator function, which takes the value 1 if the expression "." contained in it is true.
An equivalent expression is the following:
PSI = I[Total consumption > Σi≠xCi ]
where the sum of capacities is taken over all suppliers apart from x.
The PSI is a binary indicator that can be calculated hourly. If the supplier Cx is needed to supply the demand, it is pivotal and the index takes the value "1". If he is not pivotal, it takes the value "0".
Residual Supply Index (RSI)
The Residual Supply Index is a simple and effective tool in monitoring market power. It is the non-binary alternative to the PSI.The Residual Supply Index is expressed as:
RSI = (Σn1 Ci - Cx)/Last
where Cx is the capacity of the analysed supplier and the sum of Ci the capacity of all suppliers.
Receiving a result bigger than 100% is an indication that the supplier x should have little influence on the price. With a RSI smaller than 100%. the supplier x could easily practise market power. The RSI has the advantage over the PSI to be not binary and for this reason he can better indicate the increase of the structural market power.
See also
- Market form
- Herfindahl indexHerfindahl indexThe Herfindahl index is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them. Named after economists Orris C. Herfindahl and Albert O. Hirschman, it is an economic concept widely applied in competition law, antitrust and also...
- MicroeconomicsMicroeconomicsMicroeconomics is a branch of economics that studies the behavior of how the individual modern household and firms make decisions to allocate limited resources. Typically, it applies to markets where goods or services are being bought and sold...
- Market dominance strategies