1) Market Concentration

a) Critically examine the implications of the Deterministic approach to the level of seller
concentration in an industry. Refer to any empirical evidence as appropriate. (60 marks)
b) Explain the distinction between Type 1 and Type 2 industries. If there is a sustained increase
in market size in the long-run, explain how the trend in seller concentration is expected to
differ between the two industry types. (40 marks)

(a) Discuss the relative merits of the k-firm concentration ratio, the Herfindahl index and the
Hannah-Kay index of market concentration. (35 marks)
(b) Calculate the change in the level of seller concentration at the two dates shown in the table
below using the Herfindahl index in numbers equivalent form and the Hannah-Kay index
with = 1.5 and = 2.5. In each case, treat others as a single firm.

Table 1. Desktop Browser Share in the Global Internet Market (%)

Internet
Firefox
Chrome
Safari
Opera
Explorer
Apr. 2008 77.9
17.2
0.0
2.5
1.9
Nov.
52.6
22.1
18.2
5.0
1.6
2011

Others
0.5
0.5

What can you conclude from your calculations? (40 marks)

(c) To what extent do these results highlight the limitations of measures of market concentration
as a guide to the market power of firms in oligopolistic markets? (25 marks)

Critically discuss the view that, While stochastic process models have limited behavioral content,
they appear to provide remarkably accurate predictions of observed patterns of industry
concentration.
With reference to economic theory and empirical evidence, explain what you would expect to
happen to the equilibrium level of market concentration in an industry following:
(a) a decrease in the exogenous fixed costs of production;
(b) a toughening of public policy towards restrictive trading agreements;
(c) an increase in the size of market demand.

(a) Discuss what one would look for in a good measure of seller concentration in markets and
outline the relative merits of different measures of concentration. (40 marks)
Table 1. Grocery Sales Share of UK Grocery Retailers.
Tesco
Asda
Sainsburys Morrisons Safeway Somerfield M&S
2002
20.2
12.3
12.8
3.8
8.2
2.9
3.3
2007
27.6
14.1
13.8
9.9
0.0
3.9
3.8

Others
36.2
26.9

(b) Calculate the change in the level of seller concentration between the two dates shown in the
table above using:
(i) the 5-firm concentration ratio
(ii) the Herfindahl Index
(iii) and the Hannah Kay Index with = 2.5
What do you conclude from your calculations? (35 marks)
(c) To what extent does this example highlight the limitations of measures of seller concentration as
a guide to the market power of firms in oligopolistic markets? (25 marks)

Lipczynski textbook notes

What makes an adequate measure of seller concentration?
Hannah and Kay (1977) suggest 4 criteria that any adequate measure of seller concentration should
satisfy:
Concentration curve ranking criterion 2 industries A and B with equal firms. A more
concentrated if the firms cumulative market share is greater for A than B at all points in the
size distribution
Sales transfer principle A transfer of market share from a smaller to a larger firm should
always increase concentration.
Entry condition If a new firm enters an industry with a market share below a certain
threshold, concentration is reduced
Merger condition Any merger between 2 incumbent firms should always increase
concentration

N-firm concentration ratio:

where si is the share of ith largest firm in total industry sales, assets or employment.
The choice of n and size measure no crucial. Bailey and Boyle (1971) find that n-firm
concentration ratios for several values of n are highly correlated.
Theoretically good measure.
Good measure because data requirements low so easy to calculate and interpret. However,
this is also a limitation as number and size distribution of firms outside of n not considered.
Only considers a single point on the concentration curve and fails the sales transfer principle
and merger condition.

Herfindahl-Hirchman (HH) index:

Where si is the market share of firm I, and N is the total number of firms in the industry.
Where cv is the coefficient of variation of firm size.
Maximum value, HH=1 means size distribution very skewed and suggests monopoly
Minimum value, HH=1/N means industry consists of N equal-sized firms.
Satisfies all Hannah Kay criteria and gives most weight to market shares of largest firms.
Requirement for individual size data practically difficult. Needs a proper definition of
market to work well. Does not include geographical scope.
Numbers equivalent of HH index is just 1/HH. Meanings of maximum and minimum values
swap.

Hannah Kay index:

The choice of enables relative weights on size of firms to vary. Higher values of place a
greater weight on the market shares of the largest firms.
1/(1-) transforms it into numbers equivalent.
Satisfies criteria.

Trade adjusted concentration ratio:

( )
-

Qx = total sales (home and abroad) by k largest domestic producers

Xx = exports by k largest domestic producers
Q = total industry sales
X = total industry exports
M = total industry imports

Assumptions:
- The export propensity of larger firms is greater than that of smaller firms.
- No foreign supplier is one of the k largest firms.
- No own imports.
This ratio has not come up in any previous exams but worth noting formula. The merits of this are
pointed out in the limitations section below.

Technical limitations of individual measures:

- Appropriate industry definition. Properly defined industry should include substitute products
but a very tight definition can lead to all firms being considered monopolistic.
- Defining market boundaries: Concentration measures at national level tend to suggest lower
concentration than at regional. Bus service industry, in cities it is high whereas nationally,
concentration low.
- Treatment of imports and exports. Utton (1982) discusses how concentration measures can
overstate or understate the true importance of largest firms. For example a single foreign
firm may supply 40% of market but not considered in domestic measurement and so
concentration is overstated.
- Multi-product operations. Many large firms have diversified product lines but products in
different industries sometimes attributed to the industry in which it mainly operates leading to
incorrect measurements.
Kwoka (1981) compared 11 concentration measures for 119 industries and found most of the
measures are highly correlated. A single, one dimensional numerical measure cannot summarize all
relevant information (historical tradition and manager objectives just 2 more examples).

Principle Theoretical determinants of seller concentration: (Different exam question. Ill look
into it if Im bored of the other topics)
Economies of scale, entry and exit barriers, regulation, the scope for discretionary sunk cost
investment on items such as advertising and research and development, the stage reached in the
industrys life cycle, and the firms distinctive capabilities and core competencies.
Henley (1994)
Five firm concentration ratios and Herfindahl indices for 104 British manufacturing industries 19801987 indicate a fall in concentration. Changes in technological conditions important but they did not
identify if these directly changed MES or indirectly through the reduction of entry barriers. High
levels of mergers in 80s was not significant in their regression.