Industrial Organization

3. Definition of the relevant market and

concentration measures
2014/15, 2nd Semester
LEGI
Margarida Catalo Lopes

Relevant market
For two or more firms to compete, they must be in the same
market. So, it is important to correctly define the relevant
market (also for competition policy purposes). We must
define
the geographic market and
the product market

The geographic market has become wider due to economic

integration (and e-commerce).
When transportation costs are high relative to price the geographic
market will be narrower.
The same for non tradable goods.

Relevant market
Define the product market:
Use the cross price elasticity. Tells us the percentage
increase in demand for good i when the price of good j
increases by 1%. It is high among products in the same
market and low among products in different markets
cross price elasticity (i different from j)
dQ P
ij = i j
dPj Qi

> 0 i and j substitutes

< 0 i and j complements

Look at price correlations

Relevant market
Define the product market:
Perform the SSNIP test (Small, Significant, Non-transitory
Increase in Price): simulate a 5 or 10% rise in price in a
restricted market; if profits rise, the market is well defined;
if they fall, then identify main substitute, widen market
definition and restart
Qualitatively: goods have the same characteristics, so
consumers view them as close substitutes. Producers show
similar technical capabilities

Autoridade da Concorrncia aplica coimas de 9,29

milhes de euros a empresas do grupo Galp Energia
por prticas anticoncorrenciais no gs engarrafado
Em que mercado ocorreu a violao das regras da concorrncia?
A violao das regras da concorrncia pelas empresas do grupo Galp Energia ocorreu
no mercado do GPL (gs de petrleo liquefeito) em garrafa. O GPL engarrafado,
vulgarmente denominado como gs em botija, obtido a partir da refinao do
petrleo ou do gs natural, sendo essencialmente utilizado para fins domsticos no
aquecimento individual, na produo de gua quente e na cozinha.
Estima-se que mais de 2 milhes de famlias portuguesas adquirem GPL em garrafa,
suportando uma fatura que ronda os 250 /ano..

(...) as empresas do grupo Galp Energia probem os seus distribuidores de GPL em

garrafa de vender fora de uma rea geogrfica definida no contrato, mesmo em
resposta a encomendas espontneas da parte de consumidores localizados fora do
seu territrio contratual (venda passiva).
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Concentration
Having defined the relevant market, we can evaluate
concentration. This helps us tell whether the market
is closer to perfect competition or monopoly.
A given market is highly concentrated if a large
fraction of total sales lies in the hands of a small
number of firms.
The concentration degree depends on the number
and relative size of firms.
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Concentration
C

si

i=1

where si is the market share of firm i, with firms

sorted in descending order according to share.
si=qi/Q, and
firms.

Q =

, where N=total number of

i=1

C4, C5 and C8 are the most widely used Ck. However

we shall opt for the most adequate in each market. The

higher Ck the more concentrated the market. These
indexes are insensitive to rank changes inside the group
considered or outside it.

Concentration
Herfindahl-Hirshman index (HHI): H =

s
i =1

2
i

The higher H, the more concentrated the market.

H varies between 1/N (N firms of equal market
share)
H

1

N

1
N

and 1 (just one firm, H=1).

Concentration
By comparing the value of H for a given market with 1/N
we get an idea of how far we are from a market
structure with N firms of equal size.

Problems: H is a static measure; how to compute it

when there are holdings and cross-participations?
Adelman number (or equivalent number of firms)= 1/H.
Interpretation: number of equal sized firms that would
exist in a market with this value for H. Compare with the
number of existing ones and draw conclusions.

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Concentration
An example of the use of the H index in the European antitrust legislation

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Relationship between market structure

(as measured by concentration) and
competition
monopoly: a dominant firm (not necessarily just one); few
price competition, except when threat of entry is sufficient
to force incumbent firms to set low prices
(H>0.6)
perfect competition: many firms; the good is
homogeneous; perfect information; intense price
competition (the demand faced by each firm is horizontal);
if there are no barriers to entry, positive economic profits
drive new firms in and profits vanish (H<0.2)

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Relationship between market structure

(as measured by concentration) and
competition
monopolistic competition: many firms; differentiated
product; the demand faced by each firm is negatively
sloped; entry may erode existing profits
(H<0.2)
oligopoly: few firms of approximately equal size; the
market equilibrium depends on the way firms compete
(prices, quantities or other strategic variable)
(0.2<H<0.6)

The level of competition (Conduct), connected with
market Structure, is one of the factors that determine
Profitability.
(remember chapter 0)
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Volatilidade
Instability index
0 <  =

| 
 |



<1

I and H tend to be negatively correlated: in more

concentrated markets, market share stability is
higher.

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Volatilidade

Important to study the determinants of industry concentration and market

share instability simultaneously. Industry concentration should not be used as
the sole measure of market structure and competition

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