| What does concentration in a market refer to? | Concentration in a market refers to how many firms operate in the market. If there is low concentration there are many firms, but if there are few large operators then there is high concentration. The DCA uses it to understand if the industry has a competition problem - Among other things. |
| What does a firms competitive environment revolve around? And what has market concentration do do with it? | Firms’ competitive environment revolves around three key elements:
1. Number and size distribution of firms
2. Market entry and exit barriers
3. Degree of product differentiation
The seller concentration typically refers to point 1: the number and size distribution of firms. |
| What are the two levels of measuring seller concentration | 1. Aggregate concentration - firms forming part of an economy located within a given geographical boundary
• This can have implications for concentration in specific industries
• Information about importance of large, diversified firms can be revealed
• Indicate country’s regulatory environment
2. Industry or market concentration - reflects importance of large firms in a particular industry |
| Hannah and Kay (1977) suggest several criteria a specific concentration measure should satisfy. What are those? | 1. Concentration curve ranking criterion - industry A is more concentrated than industry B if firms’ cumulative market share for A is greater at all points in the size distribution.
2. Sales transfer criterion - transfer of sales from smaller to larger firms should increase measured concentration
3. Entry criterion - entry of a new firm (smaller than the average size of existing firms) should decrease measured concentration
4. Merger criterion - merger of firms should increase measured concentration |
| What is the concentration ratio? | Measures share of the industry’s largest n firms in total industry size measures such as sales, assets, employment. |
| What are the benefits and disadvantages of concentration ratio? | Advantages of the concentration ratio:
It is easy to compute since we only need information on the largest n firms and aggregate industry
It is easy to interpret - CR_n [n/N,1]
Disadvantages
n is arbitrarily chosen; different values of n can give completely different concentration measure
Only takes information few points on the concentration curve
Transfer of sales may not affect the ratio
In practice n is often 4. However, it depends on how the industry is defined. |
| What is the Hirschman-Herfindahl index (HH index) | The HH index is another way of measuring concentration based of sum squared market shares of all firms in the industry. The HH index gives more weight to larger firms, where the weights are firms’ market shares. |
| What is better, HH index or CR index for measuring market concentration? | HH index is considered the most accurate as it takes all firms into account. The CR index only considers the largest firms. CR is more easy to calculate and require less data through. Hence, HH index and CR index is a trade-off of accuracy and how easy it is to calculate. |
| What are the issues with concentration measures? | 1. It is often problematic to define a market. Hence, it becomes difficult to compare market concentration calculations.
2. Firms existing in market might be multiproduct or diversified. Hence, is it fair to assume that 100% of the firm is in the defined market? This leads to a need to only use a part of the firm which is often difficult.
3. Multiple firms in an industry might be owned by the same individual (Vertical ownership structure). Market concentration can then underestimate market power.
4. Constant concentration index over time does not capture shift in market shares (Identity problem)
5. Companies’ import /export conditions often neglected - correction necessary to assess competition in the domestic market.
6. SCP vs Chicago School. Efficiency hypothesis - maybe it’s wrong at all to use concentration measures to infer problems with competition. |
| What is the Lerner index | The Lerner index is another way of measuring concentration. It is a theoretically founded index that tells us the degree of market power as it tells us how much the actual price is higher than marginal cost. The difference between P and MC is called the mark-up: P - MC.
The Lerner index provide a key relationship: The higher the price elasticity of demand in a market, the lower is the mark-up in that market and therefore the lower the Lerner index.
Hence, if L = 0 then we are at perfect competition P = MC (Low centration/high competition). But if L has a large value that indicates a large mark-up and hence indicates high concentration (i.e., low competition). |
| How does the DCA measure concentration? | The DCA has multiple ways of measuring competition in an industry. Each way can gain an industry points:
1. Concentration ratio CR_4
CR_44 - share of the largest four firms in the total industry sales. CR_4 > 80% is considered problematic.
2. Concentration ratio CR_4 adjusted for imports.
Many firms operate internationally. To account for this, CR_4 is adjusted for imports.
3. Entry ratio - share of new entrants as a percentage of number of firms in the industry.
4. Market share mobility - absolute changes in firms’ market share between two periods.
5. Productivity dispersion. Dispersion in productivity is compared with the average productivity dispersion in the entire economy. Should not be higher than 25%.
6. Wage premium. Difference in industry wages that cannot be explained by workers’ age, work experience, skill etc. Wage premium in excess of 15% higher than the benchmark industry = problematic.
7. ROI - industry profit after tax relative to the value of the fixed assets. Return on investment in excess of 50% percent higher than the average for all industries = Problematic.
8. Price level - Price index with EU9 = 100, calculated by correcting the Eurostat PPP price figures for differences in VAT and duties. Price index in excess of 3 percent higher than EU9 price index = Problematic.
9. Public regulation of the industry. Competition is normally weaker in regulated industries .
10. Subjective evaluation. Competition authority can undertake a qualitative assessment of the industry despite the quantitative indicators. |
| How does MES affect seller concentration? Does it function as a systematic determinant of concentration? | • At MES output level, all economies of scale are exhausted. A firm cannot make any further cost savings through expansion.
• If MESq = total demand (D), a single firm can serve the market, and the industry structure is monopolistic.
• If MESq,1 + MESq,2 + … + MESq,N = total Demand, N firms serve the market, and the industry structure becomes perfect competition when N is large.
It is a systematic determinant for concentration, as it can be applied generally to all industries. |
| How does barriers of entry affect concentration and is it a systematic determinant of concentration? | • Free entry is likely to reduce concentration, assuming the entrant is smaller than average size of incumbent firms
• Free entry at a large scale is likely to decrease concentration (Increase competition)
• Exit is likely to increase concentration (Decrease competition)
It is a systematic determinant for concentration, as it can be applied generally to all industries.
The need for heavy investments, expenditure on advertisement etc. is likely to increase concentration as there are higher entry barriers and more seller concentration. |
| How can regulation reduce concentration? | Usually, government regulated industries have a high level of concentration. However, government policy can reduce concentration by disallowing mergers or discouraging restrictive practices. On the flip side, policies can increase concentration by granting exclusive property rights to selected firms, protecting domestic firms etc. |
| How can industry life cycle influence concentration? | The industry lifecycle can also influence concentration based on where in the lifecycle the industry is:
1. Introduction
- High investment required in R&D, high price/low volume, low seller concentration
2. Growth
- Market expands, economies of scale (cost saving, falling prices), new entrants due to profit, seller concentration still low, low prices to increase demand.
3. Maturity
- No more demand growth through price-cut, heavier advertisement required (increasing entry barriers), seller concentration increases.
4. Decline
- Sales and profit decline, firms leave (voluntarily or not), collusion and mergers, for surviving firms seller concentration is high |
| How can firms themselves affect concentration? | Firms can have distinctive capabilities that lead to higher concentration, such as internal organization, relationship with suppliers and distributors and specialized industry knowledge, but also innovation and reputation.
The core competences such as specialized industry knowledge, protection of specialized resources and competences from imitation and flexibility and adaptability to changing environment can also influence concentration. |
| What is the random growth hypothesis and how does it play into industry concentration? | There is randomness in a firm’s growth. Hence, past performance is rarely a good indicator for future performance. A firm’s growth is independent of its size - Law of proportionate effect (LPE) or Gibrat’s law. However, seller concentration is still not a matter of chance. There is a natural tendency for an industry to become increasingly concentrated over time such as described above in the industry lifecycle. |
