Oligopoly has a small number of large firms producing a majority of the total industry output. This means that production and sales tend to be concentrated in the hands of a relatively few firms. For many oligopoly markets, the ten largest firms often account for over 75 percent of total sales. For some oligopoly industries, the three to four largest firms account for over 90 percent of the market. Such concentration is what leads to some of the more interesting behavior of oligopoly, like collusion and nonprice competition.

The identification and measurement of concentration in an oligopoly market quite useful. Concentration measurement is generally accomplished in one of three ways.

• Market Share: The simplest measure of concentration is the share of the market held by one or more firms in the industry. This is typically computed as the fraction of total sales or total production accounted for by one or more firms. For example, OmniCola sells $460 million of soft drinks each year. Total soft drink sales in the Shady Valley market are $2,000 million. As such, OmniCola has a market share of 23 percent.


• Concentration Ratio: This measure of concentration combines the market shares for the largest number of firms in an industry to indicate the degree of market concentration. The two most popular concentration ratios are for the four or eight largest firms in an industry. More specifically a concentration ratio is the fraction of total industry activity accounted for by the four or eight largest firms in the market. For example, the top four firms in the $2-billion Shady Valley soft drink market account for $460 million, $350 million, $225 million, and $190 million worth of sales. This gives a four-firm concentration ratio of about 61 percent. Concentration ratios fall somewhere in the range of 0 to 100 percent.


• Herfindahl Index: This measure was developed to compensate for a few problems associated with concentration ratios. In particular, the standard four-firm and eight-firm concentration ratios ignore the activity of firms not included in the calculation. The Herfindahl index includes the market shares of all firms in the market. Moreover, rather than simply adding the market shares, the Herfindahl index squares each market share before adding. This little trick has the added feature of placing greater weight on larger market shares. The Herfindahl index generates values between 0 and 10,000.