Concentration Measures in Economics

Economists can use the concentration measures to measure the market power. Market concentration is a function of the number of firms and their respective shares of the total production in a market.

There are two popular concentration measures, namely, N-firm concentration ratio and Herfindahl-Hirschman Index (HHI).

N-firm Concentration Ratio

N-firm concentration is the sales of top n firms divided by the total sales in the industry, i.e., the percentage of sales held by the n largest firms in an industry. For example, 4-firm concentration ratio will be the percentage of sales held by the four largest firms in an industry.

In a market with perfect competition, this ratio would be zero. It will be 100 in a highly concentrated market. In general, a ratio of more than 60% is indicative of a high degree of concentration (oligopoly), and less than 40% indicates a competitive market.

Herfindahl-Hirschman Index (HHI)

HHI measures market concentration and is a metric used by government oversight bodies in the U.S. to determine if a merger should be allowed or blocked.

HHI calculates the sum of squared market shares for competing companies.

For an individual firm, HHI is calculated once; for a merger of two companies the HHI of the combined entity will be the sum of their individual market share HHI values.

This number is small in competitive markets. When HHI crosses a certain threshold, the government may legally challenge the proposed merger. An HHI greater than 1,800 indicates an uncompetitive market, and mergers which result in HHIs greater than 1,800 are more likely to be challenged by the Justice Department antitrust division.

Combined Entity HHI	HHI Change	Government Response
< 1,000	Irrelevant	None.
1,000 – 1,800	≥ 100	Potential legal challenge to merger.
1,800+	≥ 50	Definite government challenge to merger.

Note that a small change to HHI in a heavily concentrated industry may be more scrutinized than a large change to HHI in a highly competitive industry. In the U.S., the Justice Department will consider other factors than just the HHI, when determining whether or not to attempt to block a merger.