L5 - Concentration measures Flashcards
What are the 3 key elements of a firm’s competitive environment?
- Number and size distribution of firms
- Market entry and exit barriers
- Degree of product differentiation
What are the two levels to measure seller concentration?
Aggregate concentration: all firms that form part of an economy, located within some specific geographical boundary
Industry/market concentration: all firms classified as members of some industry or market, again located within some specific geographical boundary
Why do we want to measure aggregate concentration?
Reflects the importance of the largest firms in the economy as a whole
Typically measured as the share of the n largest firms in the total sales, assets or employment (or other appropriate size measure) for the economy as a whole.
Important as
o High aggregate concentration - implications for levels of seller concentration in particular industries AND could indicate the largest firms have opportunities to exert disproportionate degree of influence over politicians and regulators
Might reveal information about economic importance of large diversified firms, which is not adequately reflected in indicators of seller concentration in particular industries
Why do we want to measure industry/market concentration?
Reflects the importance of the largest firms in some particular industry or market
Sometimes also relevant to measure buyer concentration
What are the Hannah and Kay criteria concentration measures at industry level should fulfill?
Concentration curve ranking criterion – industry A more concentrated than industry B if firms’ cumulative market share for A is greater at all points in the size distribution - should show up
Sales transfer criterion – transfer of sales from smaller to larger firms should increase measured concentration
Entry criterion – entry of a new firm (smaller than the average size of existing firms) should decrease measured concentration
Merger criterion – merger of firms should increase measured concentration
What is included in the product market definition?
Product market definition: include all products that are close substitutes (both in production and consumption)
Cross-price elasticity of demand
o Large and positive - substitutes
o Large and negative - complements
Substitutes in production - if an increase in the price of Good 1 causes the firm to switch production from Good 2 to Good 1
Cross-price elasticity of supply
o Negative value - substitutes in production
o Large and positive - complements
What is an industry vs. a market?
Industry - firms producing similar products, using similar
technology and using inputs from the same factor markets
Market - supply/production and demand/consumption activities
What is included in the geographic market definition?
Geographic market definition - determining whether an increase in the price of a product in one geographic location significantly affects either the demand or supply and thus price in another location
If so - part of the same market
Local, regional, national, continental or global
Spatial cross-price elasticities and be used
What is the SSNIP test?
SSNIP (small but significant non-transitory increase in price) test
If the product does not itself constitute an independent market, the SSNIP identifies the product (geographic market), the nearest substitute, and tests whether the two products (geographic markets) together constitute an independent market.
The question is whether a hypothetical monopolist who produces the two products will benefit from permanently raising the price by 5-10%.
With SSNIP one tries to predict whether consumers will be likely to switch to other products and whether there are companies that will seek to enter the market.
If profitable to raise price - the two products are an independent market
Can also be applied to product definition of a market
DO NOT APPLY TO MONOPOLY
What is the n-firm concentration ratio?
Measures the share of the industry’s n largest firms in some measure of total industry size
The most widely used size measures are based on sales, assets or employment
Above 80% suggests not that intense competition, cetris paribus
What are the advantages and disadvantages of the n-concentration measure?
Advantages:
Less demanding data requirements than for other types of measures
Easy to compute and interpret
Disadvantage:
n is arbitrarily chosen; different values of n can give completely different concentration measures
No accounts is taken for the number and size distribution of firms outside n
No account is taken for size distribution within the top n firms
Transfer of sales may not affect the ratio (Hannah and Kay criteria)
What is the Herfindahl-Hirschman (HH) index?
Based on the sum of the squared market shares of all firms in the industry
Weighted sum of market shares, larger weights attached to larger firms
Max occurs when size distribution is highly skewed, i.e. one firm with a market share of almost one and N - 1 firms with market share almost 0
Min occurs when industry consists of equally sized firms. Each firm has market share of 1/N
What are the advantages and disadvantages of the HH index?
Advantages:
It takes into account all points of the concentration curve
It is easy to interpret
It satisfies the Hannah-Kay criteria
Disadvantages:
Practical difficulty of individual size data of all firms
What is the numbers equivalnet of the HH index?
Inverse measure of concentration: represents the number of equal-sized firms that would give rise to
the same value of concentration index
Min =1 (most unequal distribution) and max = N (most equal distribution)
Min occurs when HH = 1 and max occurs when H = 1/N
Useful as a measure of inequality in firm size distribution
What is the Hannah and Kay index?
The choice of a in the HK(a) index enables the relative weights attached to the larger and small firms to vary from the proportions used in the HH index.
α = 2 - HK index is same as HH
α < 2 - HK attaches relatively more weight to smaller firms and relatively less to larger than HH
α > 2 - HK attaches relatively more weight to larger and less to smaller than HH
Same positive properties as HH
The larger the α, the smaller the degree of inaccuracy if HK(α) is calculated using accurate individual data for the largest firms but estimated for smaller
What is the numbers equivalent of the HK index?
When α=2, n(2) = 1/HH
Defined for any value of a greater than zero apart from a=1
The properties and interpretation of the numbers equivalent are the same as before. For an industry with N firms, the minimum value is 1 (one dominant firm and N - 1 small firms); and the maximum value is N (all N firms are equal-sized).
What is the key difference between the n-firm concentration ratio and the HH/HK?
HH and HK assigns weights to each firm, n-firm concentration ratio just measures the share of the largest firms of the total industry
What is the key difference between HH and HK?
In HK, the choice of a means the relative weights attached to the smaller and larger firms can vary from those in HH
How can definition of the relevant market and treatment of imports and exports be a problem for concentration measures?
Definition of the relevant market:
Industry definition should allow the calculation of concentration measures that sensibly reflect market power
Hence - should include all producers of substitutes
But when is it a substitute? A matter of degree, when to draw the line
Comparisons across markets are problematic
Treatment of imports and exports: Companies’ import / export conditions are often neglected - correction necessary to assess competition in the domestic market
How can multi-product operations and ownership neglected be a problem for concentration measures?
Multi-product operations:
Typically, firm is classified as part of the industry in which its main product belongs
Hence, diversification not considered - possibly need to compute on branch/plant level which is often difficult
Concentration measures calculated from data of this kind might tend to overstate or understate concentration in both industries.
Ownership neglected:
Horizontal structures - a legal person can own more companies in the same industry.
Vertical ownership structures - concentration measures can underestimate market power (eg, ownership of plants that make important inputs to the industry)
How can the identity problem be a problem for concentration measures?
Constant concentration index over time does not capture shift in market shares (Hannah and Kay criterion, not satisfied by n concentration)
How does the Chicago School look at concentration measures?
Efficiency hypothesis - maybe it’s wrong at all to use concentration measures to infer problems with competition.
What is the entry ratio?
Share of new entrants as percentage of number of firms in the industry
Below 3% in manufacturing, 8% in others - industry assigned 2 points
Lower for manufacturing as:
o Efficiency hypothesis (Chicago School - only large firms may be able to innovate)
o Protecting domestic industries
o High barriers to entry
What is the market share mobility?
Absolute changes in firms’ market share between two periods
Has to be in absolute terms, i.e. all plus
If = 0 - no change in firms and their market share
If = 100 - all firms with a positive market share exited
You want some change; the red lamp is switched on when there is no or too little changes in firms market share between two periods - red lamp switches on
What is the Lerner index?
Tells us how much the actual price is higher than MC
The higher the price elasticity of demand, the lower the mark-up
A large value of L or large mark-up indicates high concentration - i.e. low competition
Perfect competition - Lerner index = 0
Name 6 other concentration measures
Productivity dispersion
Wage premium
Return on investment
Price level
Public regulation of the industry
Subjective evaluation
