Measurement of Industry Concentration

      There are several methods used to measure the degree to which oligopolistic industries are concentrated by largest firms. The most often used ways to measure are concentration ratios and the Herfindahl index.

Concentration Ratio
   Concentration Ration shoes the percentage of total output produced and sold by industry’s largest firms. For example, three largest U.S producers of iron, supply almost 100% of all iron resource in this country.
   When the largest three-four firms in an industry control 40% or more of the market, that industry is said to be oligopolistic. Although concentration ratios offer useful ideas about competitiveness and monopoly power of diverse industries, there are three shortcomings.

• Local Markets

   Concentration ratios relate to nations as a whole, where the markets for some goods are highly localized because of expensive transport. For example, the four-firm concentration ratio for tobacco products is just 37% in China, suggesting that this industry is a competitive one. But, when we relate this product to some specific market or town in this country, we may often find that four firms produce about 80% of the total output in that area.

• Inter-industry Competition

   Inter-industry competition is competition between the products of one industry and the products of another industry. An example to this kind of competition may serve primary metals in some industries aluminum and copper, since aluminum competes with copper in many applications. (Electric devices, robots, machineries)

• World Trade

   The data for products produced in one country only may overstate concentration ratio since in most of cases they don’t account for import competition of foreign suppliers. Although some figures show that domestic firms produce over 90% of the total output for some good, they ignore the fact that some large quantities of that good may be imported. Many of the world’s largest corporations are foreign, so many of them are spread in diverse countries.

Herfindahl Index
   The shortcomings of concentration ratio from above apply to many measures of concentration, but one of these can be eliminated: Let’s say in industry “A” one firm produces all market output, but in industry “B” five firms produce 20% of the market. The concentration ratio is 100% in both cases. But industry “A” is pure monopoly, while industry “B” is an oligopoly. Economically, monopoly power is greater in industry “A” is greater than that from industry “B”, this fact isn’t shown by identical 100% concentration ratio.
   Herfindahl index solves this problem. This index is the sum of the squared percentage market shares all firms in the industry have. In equation from:

   Where %S₁ is the percentage share of firm 1, %S₂ is the percentage share of firm 2, and so on for each firm in the industry. By squaring percentages this index give more power to firms that have larger market shares, than to smaller ones. In case that a single firm has 100% then the Herfindahl index gives its highest value- 10000. In our industry “B”, Herfinahl index will be 20²+20²+20²+20²+20² which results in 2000, which is much more less that 10000 showing less market power.(In a purely competitive industry this index will approach to zero). More market power-higher Herfindahl index.

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Price Discrimination

      In all previous articles I assumed that monopolists charge a single price to all buyers. But under some conditions monopolists can increase their revenues by charging different prices to different demanders.  By doing this kind of act monopolist is engaging in price discrimination, the practice of selling of the same product to different buyers when the price difference aren’t justified by difference in cost.
   In order to engage in price discrimination there are some conditions that must be realized:

• Market segregation– the seller should be able to differentiate the buyers into different classes, each of them having different wants and abilities to pay for the product.  This division of buyers is usually related to different elasticities of demand.
• Monopoly power– another important characteristic is that seller should be a monopolist or at least to possess some monopoly power, so that he may control the quantity output and the price.
• No resale-The original buyer mustn’t be able to resell the good or service. Otherwise, if the buyer from low-price segment is able to sell the goods purchased to buyers from high-price segment, then our seller will have some competition in high-price segment. This competition will reduce the price and will cancel seller’s price discrimination policy.

Examples of Price Discrimination
   Some movie theatre or golf clubs differentiate their charge on the basis of time ( lower rates in the night and higher rates in the evening) and age(younger- lower ability to pay, so less money is charged).  Another example can serve railroads where shipper of 1 tone of jewelry is charge more than a shipper of 1 tone of tomatoes.

Consequences of price discrimination
   Monopolist can increase its revenue by practicing price discrimination. At the same time, perfect price discrimination results in an increase of output. In this case each consumer pays the price that he or she is willing rather than to forgo the product.
   Other things equal, the monopolist that practices perfect price discrimination is producing a higher quantity of output than the monopolist that isn’t practicing it. When the non-discriminating monopolist lowers its price to sell additional unit, this lower price is applied not only to additional output but also to the prior units. So the non-discriminating monopolist’s marginal revenue falls more rapidly than the price and, marginal revenue, graphically, lies below demand curve. However when a discriminating monopolist lowers its price, this reduced price is applied only to additional units sold not to prior units. Thus marginal revenue equals price for each unit of output, graphically MR and Demand curve coincide.
   Although price discrimination results in more economic profit than that achieved by single price monopolist, it also results in greater output, so less allocative inefficiency.

Price Discrimination