- a) Compute the C4 for each industry. Which industry is most concentrated according to the C4? (10 marks)
C4=(x1 +x2 + x3+x4)/T
Where Xn=the output for the nth firm and
T=Total industry output
|Firm||Industry 1||Industry 2||Industry 3|
|Sum of C4||160||320||480|
The most concentrated industries are Industries 1 and 3, with the C4 index of 0.8.
- b) Calculate the HHI for all industries. Which industry is most concentrated according to the HHI? (10 marks)
The Herfindahl-Hirschman Index (HHI) = 10,000 x [Summation from i 1 to n, of S sub-i squared)
|Firm||Industry 1||(n/200)^2||Industry 2||(n/460)^2||Industry 3||(n/600)^2|
The most concentrated industry, according to the HHI of the three industries is Industry 1.It has the highest HHI of 2300. Industries that have an HHI of between 1000-1800 are said classified as moderately concentrated. This is the case for industry 2. Industries with HHI of more than 1800 are highly concentrated, as is industry 2 and 3.
- c) Considering that the Department of Justice’s critical value for HHI is 1800, why is Industry 1 considered more of a threat to consumer welfare than Industry 2? What are economists assuming about Firm A’s ability to raise prices in Industry 1 versus Industry 2? Explain. (20 marks)
There will be antitrust concerns in industry 1 compared to industry 2. At 1800, Industry 1 has a higher HHI index that is greater than 1800 and is considered to be highly concentrated. On the other hand, industry 2 has a concentration to be moderately concentrated and therefore can make a good ground for considering mergers. There are likely to be collusions in industry 1 that has a lot of firms that concentrated in a bid to make a kill out of the consumers. It may not be operating efficiently and consumers are likely to be paying higher than normal for the products. It also implies that the industry has uncompetitive prices in all the firms that are in the industry and chances are consumers are exploited (Zimmer, 2012. pg.25).
The case for industry 2 in relation to consumer welfare denotes that the industry favors the welfare of the consumers. There is a possibility of mergers that are believed to result in more efficiencies to promote the welfare if the consumer (Hoose, 2010, pg.100). This is unlike industry 1 that is highly concentrated and mergers may not be possible and therefore no improvement inefficiency.
What are economists assuming about Firm A’s ability to raise prices in Industry 1 versus Industry 2? Explain.
The industry that is highly concentrated as in the case of A is a monopoly and as such, it does not have efficiency. In such a situation, the industry that is highly concentrated as in the case of A can increase prices because there are collisions or the suppliers are few and buyers have relatively less bargaining power. On the other hand, firm A in industry 2 is considered as a perfectly competitive environment that cannot is a price taker and cannot control prices as in the case of Firm A in industry 1.
- d) Comparing industries 2 & 3, does the HHI do a better job than the C4 of explaining the distribution of concentration outside the top 4 firms? (20 marks)
HHI is preferred in explaining distribution and concentration of firms than C4, which only considers the first 4 firms in the industry. HHI tends to weigh all the firms against their individual characteristics such as sales and weighs it. The weighting of the market share if the industry that is done by HHI is preferred as it considers the actual position of the firm within a given industry (Perloff, Karp & Golan, 2007). Using only the C4 as shown by sales, which is equal for industries does not do a good job explaining the distribution as opposed to HHI that used their individual shares in the market. HHI shows firms that dominate in the industry, where C4 only their results.
- e) Why do you think the US merger regulations department uses the HHI measurement to direct their investigations? (10 marks)
Because C4 fails to indicate heterogeneity that exists within firms in an industry, regulators use HHI to direct their investigations. HHI will show firms that are contravening anti-trust policies and therefore harmful to consumer welfare. Blumenthal (1986, pg. 176) noted that HHI gives a reflective picture of the market concentration ratio and the “likelihood of collusions” in the industry. This analysis helps in arranging for mergers to increase the efficiency and welfare of consumers. Hence, using HHI, the regulatory department will choose the pricing of products and services in an industry. Through HHI, the department can also assess the extent to which mergers can be done to prevent mergers that will result in anti-competitive industries.
- f) Use what you have learned from this exercise, and the suggested readings to write a brief explanation of why some industries are more concentrated than others. You should include a definition of what is meant by industrial ‘concentration’ and why it is an important concept in economics. (30 marks)
Industrial concentration is an important concept as it guides economists in resource allocation decisions. It helps in ensuring firms adhere to laws that guide fair competition. It is often used in analyzing the performance of industries, firms that are less efficient are advised to seek options of merger which will not only make them more competitive but also increase the welfare of the consumers. This study also helps in assessing the likelihood of firms merging or colluding in the industry.
Industrial concentration is thus the market share that is held by individual firms within an industry. It is a measure of fragmentation of firms within an industry (MBA Econ, 2010). It is measured using C4 or HHI ratios. Though the data required in measuring the ratios, though takes a lot of time is providing information that is useful in telling of the competition in the industry or not. Knowledge of the market structures in different industries can then guide decision-makers on the best means of allocation of resources to increase market efficiency and consumer welfare (Hirschey, 2010).
Blumenthal, W (1986) Horizontal Mergers: Law and Policy, American Bar Association,
Hirschey, M (2010) Managerial Economics, New York: Cengage Learning
Hoose, D V (2010)The Industrial Organization of Banking, New York: Springer
MBA Econ (2010) Concentration Indices, http://mbaecon.wikispaces.com/Concentration++indexes+-%26nbsp%3BFour+firm+concentration+ratios,+Herfindahl+Hershman+indexes++(HHI) (Accessed 24 October 2012)
Jeffrey M. Perloff, Larry S. Karp, Amos Golan (2007) Estimating Market Power and Strategies, Cambridge: Cambridge Unioversity Press
Zimmer, D (2012) The Goals of Competition Law Edward Elgar Publishing