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 DEMAND SPACE: The area on or beneath a demand curve. Buyers are willing and able to purchase any demand price-quantity demanded combination that places them on or below the demand curve, but not above. The reason is that the demand curve represents the maximum demand price for a given quantity demanded or the maximum quantity demanded for a given demand price.

FOUR-FIRM CONCENTRATION RATIO:

The proportion of total output in an industry produced by the four 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 four-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 four largest firms in the industry.
The four-firm concentration ratio is calculated based on the market shares of the largest firms in the industry. A four-firm concentration ratio over 90 (that is, 90 percent of industry output is produced by the four largest firms) is a good indication of oligopoly and that these four firms have significant market control.

Alternatively a four-firm concentration ratio of 0.001 (that is, the four 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 four largest firms have very little market control. However, because there is a fine line between oligopoly and monopolistic competition, 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 four-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 four-firm concentration ratios are presented in the exhibit to the right.

Concentration ratios range from 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 viewed as highly concentrated. 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 calculated, 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 four firms in the industry, then dividing by the total. Alternatively, the market shares of the top four firms can be calculated individually, then summed.

The four-firm concentration ratio is the sum of total sales or the top four firms (OmniCola, Juice-Up, Super Soda, and King Caffeine) divided by the industry total. These four firms account for \$1,225 million worth of soft drink sales, which is 61.25 percent of the overall market. Or the market shares of the top four firms (23 percent, 17.5 percent, 11.25 percent, and 9.5 percent) can be summed, which is also 61.25 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, a four-firm concentration ratio for the Shady Valley soft drink industry of 61.25 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 four firms has an equal \$306.250 million in sales, the concentration ratio is 61.25 percent. Alternatively, the concentration ratio is 61.25 percent if OmniCola has \$1,200 million in sales and the next three firms account for only \$25 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 four firms have nearly equal sales than if one firm has significantly more sales than the others.

 <= FOUR ESTATES FOUR-SECTOR AGGREGATE EXPENDITURES LINE =>

Recommended Citation:

FOUR-FIRM CONCENTRATION RATIO, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: June 22, 2024].

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