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 is 1,000 (option c).

Step-by-step solution

Identify the Formula for the Herfindahl Index

The Herfindahl Index, also known as the Herfindahl-Hirschman Index (HHI), is calculated as the sum of the squares of the market shares of all the firms in the industry. The formula is: \[ HHI = \sum_{i=1}^{N} (MS_i)^2 \] where \( MS_i \) is the market share of firm \( i \).

Calculate the Market Share Squares

Each firm has a market share of 10%. To use in the formula, convert this percentage to a decimal: 10% = 0.10. Now, calculate the square of this market share: \( (0.10)^2 = 0.01 \).

Sum the Market Share Squares

There are 10 firms, and each has a market share square of 0.01. Sum these squares to find the HHI. \[ HHI = 10 \times 0.01 = 0.10 \]

Convert the HHI to a Percentage Scale

Since the HHI is typically expressed out of 10,000, convert it from a decimal: \( 0.10 \times 10,000 = 1,000 \).

Interpret the Result

The calculated HHI is 1,000, which corresponds to option c. This indicates a moderately concentrated industry.

Key concepts

Market Concentration

Market concentration refers to the degree to which a few firms dominate total sales in an industry. It provides insight into the structure and competition level in that industry. High market concentration typically suggests less competitive markets, where only a few firms have significant control. Conversely, low market concentration indicates a more competitive environment with many firms holding small market shares.
For example, if an industry consists of only two firms sharing the entire market, it would be considered highly concentrated. The market concentration often serves as a preliminary indication of potential monopolistic behavior or competitive markets. Evaluating market concentration is essential for understanding the dynamics of any industry, enabling regulators and stakeholders to make informed decisions.

Competition Measurement

In the realm of industrial economics, competition measurement is crucial to understanding the competitive dynamics of markets. One common measure used for competition is the Herfindahl-Hirschman Index, or HHI.
The HHI is calculated by summing the squares of the individual market share percentages of all companies within the industry. This provides a single number that reflects the market's competitive environment. An HHI below 1,500 is regarded as unconcentrated and indicates high competition, while an HHI between 1,500 and 2,500 suggests moderate concentration. Values above 2,500 typically denote highly concentrated markets with limited competition.
The advantage of using the HHI lies in its sensitivity to the distribution of market share. It considers both the number of firms and their respective market shares, offering a more nuanced view compared to other measures like the simple concentration ratio.

Industrial Organization

Industrial organization is the field of economics that studies the structure of industries and how firms engage in competition. It explores how businesses are organized internally and the degree of competition between them.
This field helps to analyze how different market structures—such as monopolies, oligopolies, and competitive markets—impact efficiency and the behavior of firms. Industrial organization also examines regulatory policies and their effectiveness in promoting competition and curbing monopolistic practices.

• It provides insights into pricing strategies, product differentiation, and barriers to entry.
• Understanding industrial organization enables stakeholders to predict and influence market outcomes effectively.
• It emphasizes the balance between free-market competition and regulation, aiming to foster environments that encourage innovation and consumer choice.

Efforts in this field help ensure that industries operate in ways that benefit society by balancing corporate interests with consumer welfare.