Question

There are 10 firms in an industry, and each firm has a market share of 10 percent. The industry's Herfindahl index is: a. 10 b. 100 c. 1,000 d. 10,000

Short answer

The Herfindahl index for this industry is 1,000.

Step-by-step solution

Understanding the Herfindahl Index

The Herfindahl Index, or Herfindahl-Hirschman Index (HHI), is a measure of market concentration and is calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers. The formula to calculate HHI is: \[ HHI = S_1^2 + S_2^2 + \ldots + S_n^2 \]where \( S_i \) is the market share of firm \( i \) expressed in percentage terms.

Identify Market Shares

Each firm in the industry has a market share of 10%. This means for each firm \( S_i = 10 \). Since there are 10 firms, \( n = 10 \).

Square Each Firm's Market Share

Square the market share of each firm. \[ S_1^2 = 10^2 = 100 \]Each of the 10 firms has the same market share, so the calculation will be the same for each firm.

Sum the Squared Market Shares

Sum the squared market shares for all 10 firms.\[ HHI = 10 \times 100 = 1000 \]This is because each firm contributes 100 to the index and there are 10 firms.

Key concepts

Market Concentration

Market concentration is an important concept for understanding how power is distributed among firms within an industry. It refers to the extent to which a small number of firms dominate the total sales, productivity, or some other relevant metric. In industries with high market concentration, a few firms hold the majority of the market share. This often leads to less competition, which can affect prices and product availability.

• High market concentration: Fewer firms dominate.
• Low market concentration: Many firms have smaller market shares.

Market concentration is typically measured using tools like the Herfindahl-Hirschman Index (HHI) which offers a numerical representation of industry concentration by considering each firm's market share.

Market Share Calculation

Calculating market share involves determining the proportion of sales or productivity one firm has in comparison to the entire industry. It is expressed as a percentage and provides insight into a company's size relative to its competitors.

The basic formula for calculating market share is:

• Market Share = (Company's Sales / Total Market Sales) × 100

For instance, if a company sells $10 million of products in a market that totals $100 million in sales, its market share is 10%. This percentage is essential for further calculations, such as computing the HHI, to analyze market concentration.

Competition Measurement

Understanding how to measure competition is essential for assessing the health of a market. Competition measurement helps to determine how many firms are actively vying for market share and how aggressive the competitive dynamics are. The HHI is a popular tool for this, as it provides a clear numerical indicator of competition levels.

Higher HHI values signify greater market concentration, suggesting less competition. A lower HHI indicates a more competitive market, where market power is more evenly distributed among businesses.

• An HHI under 1,500 is generally considered a competitive marketplace.
• An HHI between 1,500 and 2,500 suggests moderate concentration.
• An HHI above 2,500 indicates high concentration.

Industrial Organization

Industrial organization is a field of economics that examines how firms operate and compete in different market settings. It explores the structures, strategies, and behaviors of companies to understand how they influence market outcomes.

Key elements of industrial organization include:

• Market structure: The number and size distribution of firms.
• Firm behavior: Strategies firms employ such as pricing, product differentiation, and mergers.
• Market performance: Overall productivity, profitability, and consumer benefit.

Through industrial organization, economists can gain insights into how firms work within markets and how regulatory frameworks can shape competitive dynamics to foster efficiency and innovation.