Question

The four-firm concentration ratio for audio equipment makers is 30 and for electric lamp makers it is \(89 .\) The HHI for audio equipment makers is 415 and for electric lamp makers it is \(2,850 .\) Which of these markets is an example of monopolistic competition?

Short answer

Audio equipment makers' market (CR4 = 30, HHI = 415) is an example of monopolistic competition.

Step-by-step solution

Understand Concentration Ratios and HHI

The four-firm concentration ratio (CR4) measures the market share of the four largest firms in an industry. A high concentration ratio indicates less competition. The Herfindahl-Hirschman Index (HHI) is another measure of market concentration, calculated by squaring the market share of each firm in the industry and then summing these squares. Higher HHI values indicate higher market concentration.

Evaluate Audio Equipment Makers

For audio equipment makers, the CR4 is 30, meaning that the top four firms control 30% of the market, and the HHI is 415. These values indicate a market with many competitors and low concentration, suggesting monopolistic competition.

Evaluate Electric Lamp Makers

For electric lamp makers, the CR4 is 89, meaning that the top four firms control 89% of the market, and the HHI is 2850. These values show a high market concentration, indicating an oligopoly or near-monopoly.

Compare and Conclude

Monopolistic competition is characterized by a lower concentration ratio and HHI, as many firms compete with each other. The high CR4 and HHI values for electric lamp makers suggest high market concentration, ruling out monopolistic competition.

Final Answer

Given the values, it is clear that the audio equipment market, with lower concentration levels (CR4 = 30 and HHI = 415), is an example of monopolistic competition.

Key concepts

Concentration Ratio

The concentration ratio is a fundamental concept in understanding market structures. It measures the total market share held by the largest firms within an industry. For example, a four-firm concentration ratio (CR4) looks at the combined market share of the top four firms. If the CR4 is high, it suggests that a few firms dominate the market, implying less competition.
In the provided exercise, the four-firm concentration ratio for audio equipment producers is 30. This means the top four firms control 30% of the market, indicating the presence of many competitors and a more competitive market.

• For audio equipment makers: CR4 = 30
• For electric lamp makers: CR4 = 89

A CR4 of 89 for electric lamp makers shows that they dominate 89% of the market, suggesting a market with fewer competitors and potentially an oligopolistic structure. The concentration ratio helps quickly assess the competitiveness within an industry.

Herfindahl-Hirschman Index

The Herfindahl-Hirschman Index (HHI) is another key measure of market concentration. Unlike the concentration ratio, HHI takes into account the entire distribution of market shares across all firms. The index is calculated by squaring each firm's market share and then summing the resulting numbers. A higher HHI indicates higher market concentration.
In the given exercise, we see:

• HHI for audio equipment makers: 415
• HHI for electric lamp makers: 2850

These values clearly illustrate that the electric lamp market is more concentrated than the audio equipment market. Markets with HHI below 1,500 are considered competitive, those between 1,500 and 2,500 are moderately concentrated, and those above 2,500 are highly concentrated. Thus, the high HHI of 2,850 for electric lamp makers indicates very high concentration, typical of a market with few dominant players.

Market Structure

Market structure refers to the organizational characteristics of a market. It includes the number of firms, market share distribution, and how these characteristics affect competition. Common market structures are:

• Perfect Competition
• Monopolistic Competition
• Oligopoly
• Monopoly

In monopolistic competition, many firms sell differentiated products. High competition and low entry barriers are typical traits. For instance, the audio equipment market, with its CR4 of 30 and HHI of 415, signifies monopolistic competition.
In contrast, the electric lamp market, with its CR4 of 89 and HHI of 2850, resembles an oligopolistic structure, where a few firms dominate, limiting competition highly. Understanding market structures helps identify the level of competition and potential for new entrants.

Oligopoly

An oligopoly is a market structure where a small number of firms hold significant market power. This can lead to limited competition and higher prices. In an oligopoly, firms may produce similar or differentiated products, but each firm's decisions can significantly impact the market.
For example, the exercise shows that the electric lamp market has a CR4 of 89 and HHI of 2850, indicating an oligopoly. This high concentration suggests that just a few firms control the majority of the market. Barriers to entry are typically high, and firms may engage in practices like price-fixing or forming cartels to maintain their market power.
Oligopolies are common in industries with high initial investment costs and complex technologies, like automotive manufacturing or telecommunications.

Market Share

Market share represents a company's portion of total sales in an industry. It is a vital indicator of a company's competitiveness within a market. Higher market share typically means more influence over pricing and supply.
In the exercise, the market shares of firms help compute the CR4 and HHI, providing insights into the competitiveness of the markets.

• Audio equipment makers: Top four firms hold 30% of the market
• Electric lamp makers: Top four firms hold 89% of the market

The high market share of the top firms in the electric lamp industry demonstrates how they dominate the market, leading to less competition. Conversely, the lower market share concentration in the audio equipment market indicates more competitive dynamics with multiple players vying for market control.