Econ 140 Chapter 7
Terms in this set (33)
measures the market concentration of an industry's 50 largest firms in order to determine if the industry is competitive or nearing monopoly.
The sum of the squared market shares of firms in a given
industry, multiplied by 10,000.
squaring the market share for each firm (up to 50 firms) and then summing the squares.
In a perfectly competitive market, HHI approaches zero.
In a monopoly, HHI approaches 10,000. If the one largest firm has 100% of the market share, HHI = 1002 = 10,000.
R = Et/Ef
Et = elasticity of demand for the total market
Ef = elasticity of demand for the product of an individual firm
Four Firm Concentration Ratio
Measures the total market share of the four largest in an industry
(X1 + X2 + X3 + X4)/total sales of all firms
A concentration ratio that ranges from 0% to 50% may indicate that the industry is perfectly competitive,
though the industry may be an oligopoly if the ratio is near 50%. A ratio between 0% and 50% is considered low concentration.
Medium concentration occurs when an industry's ratio ranges from 50% to 80%. This indicates that the industry is an oligopoly.
High concentration occurs when the concentration ratio ranges from 80% to 100%, a level that indicates the industry is an oligopoly.
If the concentration ratio of one company is equal to 100%, this indicates that the industry is a monopoly.
measure of market power measured by the difference between price and marginal cost expressed as a percentage of price.
For a monopoly, this ratio is equal to the reciprical of the price elasticity of market demand.
L= (P-MC)/P = 1/Em (price elasticity of market demand)
P= (1/1-L) x MC
By what factor does this firm mark up its price over marginal cost?
P/MC = 1/1-L
Problems of Lerner index
1. the reported rates represent accounting and not economic profits.
- Economic profits consider the opportunity cost of all resources and not just the resources that are purchased by the company
- Accounting profits generally overstate economic profits and sometimes complicate comparisons across companies.
Monopolistically Competitive Industry
1. Many sellers.
2. Easy entrance.
3. Differentiated products.
4. Local Advertising.
Industry A has a four-firm concentration ratio of 0.005 percent and a Herfindahl-Hirschman index of 75. A representative firm has a Lerner index of 0.45 and a Rothschild index of 0.34.
Monopolistically competitive industry.
Industry B has a four-firm concentration ratio of 0.0001 percent and Herfindahl-Hirschman index of 55. A representative firm has a Lerner index of 0.0034 and Rothschild index of 0.00023.
Perfectly competitive industry.
Industry C has a four-firm concentration ratio of 100 percent and Herfindahl-Hirschman index of 10,000. A representative firm has a Lerner index of 0.4 and Rothschild index of 1.0.
Industry D has a four-firm concentration ratio of 100 percent and Herfindahl-Hirschman index of 5,573. A representative firm has a Lerner index equal to 0.43 and Rothschild index of 0.76.
Dansby-Willig index is higher in industry Y.
A slight increase in output in industry Y will have the greatest impact on increasing social welfare
Forey, Inc., competes against many other firms in a highly competitive industry. Over the last decade, several firms have entered this industry and, as a consequence, Forey is earning a return on investment that roughly equals the interest rate. Furthermore, the four-firm concentration ratio and the Herfindahl-Hirschman index are both quite small, but the Rothschild index is significantly greater than zero. Based on this information, which market structure best characterizes the industry in which Forey competes?
Monopolistically competitive industries have concentration measures close to zero,
but since each firm's product is slightly differentiated, the Rothschild index will be greater than zero (unlike perfectly competitive markets).
the merger may be challenged the postmerger HHI is greater than 2,500 and the change in HHI is between 100 and 200
HHI > 1800, change in HHI > 100
the postmerger HHI is greater than 2,500 and the change in HHI is between 100 and 200
Suppose Fiat recently entered into an Agreement and Plan of Merger with Case for $4.3 billion. Prior to the merger, the market for four-wheel-drive tractors consisted of five firms. The market was highly concentrated, with a Herfindahl-Hirschman index of 3,055. Case's share of that market was 11 percent, while Fiat comprised just 5 percent of the market. If approved, by how much would the postmerger Herfindahl-Hirschman index increase?
If approved, the merger would raise the HHI
by 10,000[(0.11 + 0.05)^2 - (0.11)^2 - (0.05)^2] = 110 points.
This means the postmerger HHI would be 3165 ( = 3055 + 110).
Since the postmerger HHI is greater than 2,500 and the change in HHI is between 100 and 200, the merger may be challenged - but other factors will be considered.
A horizontal merger is a merger or business consolidation that occurs between firms that operate in the same space, as competition tends to be higher and the synergies and potential gains in market share are much greater for merging firms in such an industry.
Merger a: Two major players in Internet services and retailing-Amazon.com and ebay-merge.
reduces the number of firms that compete in a production market.
Reduce the number of competitors
This increases the four firm concentration ratio and H.H.I
involves the integration of different product lines into a single firm.
For example if cigarette maker and cookie manufacturer merged into a single firm
Merger b: Cigarette maker Philip Morris merges with the Miller Brewing Company.
the integration of two or more firms that produce components for a single product.
Merger c: Lockheed Martin, a large firm that manufactures aircraft, merges with United States Steel.
Which of the following would most likely be scrutinized (inspect) under the FTC and DOJ Horizontal Merger Guidelines?
the merging of the production of a similar products into a single firm. Example: Two computer products merging into a single firm. To enjoy the cost of savings of economies of scale or scope and to enhance their market power.
various stages in the production of a single production of a single product are carried out in a single firm
Factors that effect managerial decisions including the number of firms competing in a market the relative size of firms, technological and cost consideration which firms can enter or exit industry
Revolves around casual view, market structure, conduct and performance
- Factors like technology, concentration and market conditions.
- Individual firm behavior in the market.
- Pricing decisions, advertising decisions and R&D decisions, among other factors.
- Resulting profit and social welfare that arise in the market.
The Feedback Critique
Has no one way casual link, conduct can effect market structure, and market performance can affect conduct as well as market structure.
behavior of firms also tends to differ across industries. Charge higher markups than other industries
1. Price markup over costs.
2. Integration and merger.
3. Advertising expenditures.
4. Research and development expenditures
- gain a technological advantage, with the aim of acquiring a patent. (license)
refers to the profits and social welfare that result in a given
= CS + PS.
Dansby-Willig Performance Index measure
by how much social welfare would improve
if firms in an industry expanded output in a
socially efficient manner.
Dansby-Willig Performance Index
Ranks industries according to how much social welfare would improve if the output in an industry were increased by a small amount.
is measured by industry profitability and social welfare.
There are many firms each one is small and relative to the entire market
Capital Intensive Industries
rely on equipment and machines to produce goods and services
North American Industry Classification System (NAICS)
The industry classification systems provide information about different businesses in the US economy.
The NAICS is a standardized classification system for the three partners of NAFTA (North American Free Trade Agreement): US, Canada and Mexico.
This helps compare industry trends among NAFTA partners.
Only the 6th digit of the NAICS code is country specific (to accommodate special identification needs in different countries).
US firm having an NAICS code of 448310
The first two digits tell us that the firm belongs to the sector called Retail Trade (44-45).
The first three digits show that the firm belongs to a subsector called Clothing and Clothing Accessories Store (448).
The first four digits show that the firm belongs to an industry group called Jewelry, Luggage, and Leather Goods Stores (4483)
The first five digits show the NAICS industry that the firm is a part of; here Jewelry Stores (44831).
The six-digit code shows that the firm belongs to the national industry - Jewelry Stores (448310).
factors that create barriers to entry
Economies of scale.
The Casual View
Market structure "causes" firms to behave in a certain way.
... this behavior, or conduct, "causes" resources to be allocated in certain ways.
... this resource allocation leads to "good" or "bad" performance.