Question

How do we measure a Herfindahl-Hirshman Index? What does a low measure mean about the extent of competition?

Short answer

High competition.

Step-by-step solution

Step1. Concept

Herfindahl-Hirshman Index is a measure of monopoly power in a market. Higher the value, lower is the competition in the market, i.e. high monopoly power.

Step2. Calculation

Let there be 5 firms in the market with the following market shares:

A: 40%

B: 30%

C: 15%

D: 10%

E: 5%

Herfindahl-Hirshman Index value:

${40}^2+{30}^2+{15}^2+{10}^2+5^2=2850$

So, 2850 is the Herfindahl-Hirshman Index value for the example considered.

Step3. Implication

A low value of the index indicates the market is consisting of large number of firms and that the power is not concentrated in few hands.

In other words, it implies a highly competitive market.