Tuesday  September 10, 2024
 AmosWEB means Economics with a Touch of Whimsy!
 PERFECT COMPETITION CHARACTERISTICS: The four key characteristics of perfect competition are: (1) large number of small firms, (2) identical products sold by all firms, (3) freedom of entry into and exit out of the industry, and (4) perfect knowledge of prices and technology. These four characteristics mean that a given perfectly competitive firm is unable to exert any control whatsoever over the market.

EIGHT-FIRM CONCENTRATION RATIO:

The proportion of total output in an industry produced by the eight largest firms in an industry. This is one of two common concentration ratios. The other is the eight-firm concentration ratio. Another related measure is the Herfindahl index. The eight-firm concentration ratio is commonly used to indicate the degree to which an industry is oligopolistic and the extent of market control held by the eight largest firms in the industry.
The eight-firm concentration ratio is calculated based on the market shares of the eight largest firms in the industry. An eight-firm concentration ratio over 90 (that is, 90 percent of industry output is produced by the eight largest firms) is a good indication of oligopoly and that these eight firms have significant market control.

Alternatively a eight-firm concentration ratio of 0.001 (that is, the eight largest firms are responsible for one-thousandth of one percent of industry output) is good indication that the industry is monopolistically competitive and that the eight largest firms have very little market control. However, because there is a fine line between oligopoly and monopolistic competition blend into, there is no distinct concentration ratio that can be used to separate one market structure from the other.

### High, Medium, and Low

Concentration Levels

Level Ratio

High80% to 100%
Medium50% to 80%
Low0% to 50%

Concentration ratios, especially the eight-firm concentration ratio, are designed to measure industry concentration, and by inference the degree of market control. While there are no "absolutes" when it comes to evaluating concentration, common levels and corresponding eight-firm concentration ratios are presented in the exhibit to the right.

Concentration ratios range for a low of 0 percent to a high of 100 percent. At the low end, a 0 percent concentration ratio indicates an EXTREMELY competitive market. At the high end, a 100 percent concentration ratio means an extremely concentrated oligopoly or even monopoly if the ONE-firm concentration ratio is 100 percent.

Between these two extremes, concentration ratios can fall into low, medium, and high concentration.

• Low Concentration: A concentration ratio of 0 to 50 percent is commonly interpreted as an industry with low concentration. Monopolistic competition falls into the bottom of this with oligopoly emerging near the upper end.

• Medium Concentration: A concentration ratio of 50 to 80 percent is considered an industry with medium concentration. These industries are very much oligopoly.

• High Concentration: An industry with a concentration ratio of 80 to 100 percent is view as highly concentration. Government regulators are usually most concerned with industries falling into this category.

### The Shady Valley Soft Drink Industry

Soft Drink Sales
To see how concentration ratios are calculate, consider the Shady Valley soft drink industry. This table presents the annual sales of the top eight soft drinks in the greater metropolitan Shady Valley area (plus an "Other" category). OmniCola is, of course, the favorite of Shady Valley soft-drink connoisseurs, ringing up total sales of \$460 million per year. Juice-Up is also quite popular, with \$350 million of sales. Most people are likely to recognize their favorite beverage on the list of the top eight. If not, it is included in the "Other" category. Total soft drink industry sales are \$2,000 million per year.

Concentration ratios can be calculated in one of two essentially identical ways. The first is to sum total sales of the top eight firms in the industry, then dividing by the total. Alternatively, the market shares of the top eight firms can be calculated individually, then summed.

The eight-firm concentration ratio is the sum of total sales or the top eight firms (OmniCola, Juice-Up, Super Soda, King Caffeine, Mega Cola, Hometown Brew, Frosty Grape, Cola-Riffic) divided by the industry total. These eight firms account for \$1,570 million worth of soft drink sales, which is 78.5 percent of the overall market. Or the market shares of the top eight firms (23 percent, 17.5 percent, 11.25 percent, 9.5 percent, 6.15 percent, 4.35 percent, 3.6 percent, and 3.15 percent) can be summed, which is also 78.5 percent.

This measure indicates that the Shady Valley soft drink industry falls within the medium concentration range.

### Concentration and Competition

Concentration ratios only provide an indication of the oligopolistic nature of an industry and suggest the degree of competition. However, it does not provide a lot of detail about competitiveness of the industry.

For example, an eight-firm concentration for the Shady Valley soft drink industry of 78.5 suggests a medium level of concentration and a modest degree of competition. This ratio, however, can be achieved in a number of ways. If each of the top eight firms has an equal \$196.25 million in sales, the concentration ratio is 78.5 percent. Alternatively, the concentration ratio is 78.5 percent if OmniCola has \$1,500 million in sales and the next three firms account for only \$70 million in sales.

Even though the concentration ratio is the same in both cases, the degree of competition is likely to differ. The oligopolistic industry is more competitive if eight firms have nearly equal sales than if one firm has significantly more sales than the others.

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Recommended Citation:

EIGHT-FIRM CONCENTRATION RATIO, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: September 10, 2024].

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