VERTICAL ADDITION: In graphical analysis, the technique of combining two curves by adding the value of the variable on the vertical or Y axis for a given value of the variable on the horizontal or X axis. This is commonly used for deriving the demand curve for a public good from a set of individual demand curves. The demand price that each individual buyer is willing to pay is added for a given quantity to identify the total benefits obtained.
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A family of measures of the proportion of total output in an industry that is produced by a given number of the largest firms in the industry. The two most common concentration ratios are for the four largest firms and the eight largest firms. The four-firm concentration ratio is the proportion of total output produced by the four largest firms in the industry and the eight-firm concentration ratio is proportion of total output produced by the eight largest firms in the industry. Concentration ratios are commonly used to indicate the degree to which an industry is oligopolistic and the extent of market control of the largest firms in the industry. A related measure is the Herfindahl index. Concentration ratios are 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 blend into, there is no distinct concentration ratio that can be used to separate one market structure from the other.
Two Common RatiosThe two most common concentration ratios are for the four largest firms and the eight largest firms.
While concentration ratios for other numbers of firms can be calculated, these two are the most common. As such, they have become something of analytical standards in the study of market structures. This means they are also readily comparable from industry to industry.
- Four-Firm Concentration Ratio: This concentration ratio measures the total market share held by the four largest firms in the industry.
- Eight-Firm Concentration Ratio: This concentration ratio measures the total market share held by the eight largest firms in the industry.
High, Medium, and Low
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 the corresponding four-firm concentration ratios are presented in the exhibit to the right.
|80 percent to 100 percent
|50 percent to 80 percent
|0 percent to 50 percent
Concentration ratios range for a low of 0 percent to a high of 100 percent.
Between these two extremes, concentration ratios can fall into low, medium, and high concentration.
- No Concentration: At the low end, a 0 percent concentration ratio means perfect competition or at the very least monopolistic competition that is EXTREMELY competitive. The number of firms is so large that four largest firms have 0 percent of the market.
- Total Concentration: At the high end, a 100 percent concentration ratio means an extremely concentrated oligopoly. If the calculation is based on a ONE-firm concentration ratio, the a 100 percent value means monopoly.
- 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 high concentration. Government regulators are usually most concerned with industries falling into this category.
The Shady Valley Soft Drink Industry
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.
|Soft Drink Sales
Concentration ratios can be calculated in one of two essentially identical ways. The first is to sum total sales of the top four (or eight) firms in the industry, then divide by the total. Alternatively, the market shares of the top four (or eight) 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. The top eight firms in the market account for $1,520 million in sales, which is 78.50 percent of the market.
Both measures indicate that the Shady Valley soft drink industry falls within the medium concentration range.
Concentration and CompetitionConcentration ratios only provide an indication of the oligopolistic nature of an industry and suggests the degree of competition. However, it does not provide a lot of detail about competitiveness of the industry.
For example, a four-firm concentration 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 identical $306.250 million in sales, the concentration ratio is 61.25 percent. Alternatively, the concentration ratio is 61.25 percent if OmniCola had $1,200 million in sales and the next three firms accounted 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 likely to be more competitive if four firms have nearly equal sales than if one firm has significantly more sales than the others.
CONCENTRATION RATIOS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: February 24, 2024].
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