Business Concentration

Prof. Tarun Das,

IILM, New Delhi

Business Concentration- Prof. T. Das 1

Contents of this presentation
1. Market Power and Learner Index
2. Measures of Business Concentration
3. Examples
4. Relation Between Market power and
Business Concentration
5. Review Questions

Business Concentration- Prof. T. Das 2

 1.1 Market power and Lerner Index
1. Market power is the ability of the price-
setting firm to raise their prices without
loosing their market share.
2. Lerner Index =(P-MC)/P = (P-MR)/P
= [P-P(1+1/Ep)]/P = 1- (1+1/Ep)
= -1/ Ep where Ep is the price elasticity
of demand.
3. Market power varies inversely with price
elasticity of demand, and equals zero
under perfect competition.

Business Concentration- Prof. T. Das 3

 1.2 Determinants of Market power
1. Strong barriers to entry due to
government licensing, investment and
franchise policies.
2. Existence of very large firms with
economies of scale.
3. Input barriers and immobility of inputs
4. Loyalties to brand names/ trade marks
5. Consumers lock-in due to large
switching cost caused by installation
and other costs.
6. Network externalities

Business Concentration- Prof. T. Das 4

 2.1 Business concentration
Market power is closely related to business
concentration. It means the share enjoyed
by dominant firms in an industry. There
are various indices to measure business
concentration. An ideal concentration
ratio has the following properties;
 (a) It depends on sizes of all firms in an
industry, and it is unaffected by any
permutation of sizes i.e. We do not want
to know who are the owners of the firms.
It is called the property of anonymity or
impartiality.
(b) It ranges in between zero (in the case of
perfect competition) and unity (in the
case of monopoly).
Business Concentration- Prof. T. Das 5
 2.2 Properties of Ideal
Concentration Ratios
(c) It is homogeneous of degree zero in sizes
of all firms i.e. if all sizes rise or fall equi-
proportionately, then the concentration ratio
remains unchanged. It also means that it is
independent of units of measurement.
(d) An equal absolute increase in sizes of all
firms leads to reduction of business
concentration, and an equal absolute
reduction of sizes of all firms leads to an
increase of business concentration.
(e) A transfer of size from the smaller to the
larger firm increases the degree of business
concentration and vice versa.
 

Business Concentration- Prof. T. Das 6

 2.3 Concentration Ratios

Concentration ratio depends of size of

firms. Sizes can be measured by output,
turnover, sales, capital stocks, profits etc.
Let us assume that there are n firms in an
industry with levels of turnover (T1, T2,
T3, ……Tn) arranged in descending order
i.e. T1 ≥T2≥ T3≥ ….≥Tn.
Qj = Share of the j-th firm in total turnover
(TT) of the industry = Tj/ TT = Tj / Σ Tj
Where TT = Σ Tj = T1 + T2+ T3+….+Tn

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 2.4 Concentration ratio (CR)

(a) Concentration ratio (CR) = Share of top

k (say one, two, or three) firms
combined together. If there is monopoly
(i.e. only one firm), then CR equals unity;
otherwise it is less than 1. In the case of
perfect competition having very large
number of firms, each firm has
negligible share and CR tends to zero. In
all other cases, CR ranges in between
zero and unity.
 
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2.4-A Example- Concentration Ratio
Sales- Sales- Shares- Shares-
Ind.A Ind.B Ind.A Ind.B
40 30 0.40 0.30
30 25 0.30 0.25
15 20 0.15 0.20
10 15 0.10 0.15
5 10 0.05 0.10
Total=10 100 1 1
0
CR1 (%) 40 30
CR2 (%) 70 55
Business Concentration- Prof. T. Das 9
CR3 (%) 85 75
2.5 Herfindahl and Hirschmann (HH)

(b)  Herfindahl and Hirschmann (HH) index

= It equals the sum of the squares of
shares of individual firms = Σ Qj². As in
the case of CR, HH equals 1 in the case
of monopoly, and zero in the case of
perfect competition, and CR ranges in
between zero and unity in all other
situations. If all the firms have equal
shares in output, then Qj=1/n, and HH =
Σ (1/n) ² = 1/ n.
 
Business Concentration- Prof. T. Das 10
 2.5-A Example- HH Index
Sales-A Sales-B Ind-A Ind-B
(Share)² (Share)²
    40 30 0.16 0.09
30 25 0.09 0.0625
15 20 0.0225 0.04
10 15 0.01 0.0225
5 10 0.0025 0.01
Total=10 100 0.285 0.225
0
HH Index 0.285 0.225
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 2.6 Hall and Tideman Index (HT)

(c) Hall and Tideman Index (HT)

= 1 / ( 2 Σ Rj x Qj– 1)
where Rj is the rank of the firm, the
largest firm has rank 1, next largest has
rank 2 and the smallest firm has rank n.
If all the firms have equal shares,
HT = 1 / [2n x (n+1)/ 2n –1]
= 1/n.
 
 

Business Concentration- Prof. T. Das 12

 2.6-A An Example- HT Index
Sales-A Sales-B Ind-A Ind-B
Rj x Qj Rj x Qj
  40 30 1x0.4=0.4 1x0.3=0.3
30 25 2x0.3=0.6 2x0.25=0.5

15 20 3x0.15=0.45 3x0.2=0.6

10 15 4x0.1=0.4 4x0.15=0.6

5 10 5x0.05=0.25 5x0.1=0.5

T=100 100 Sum=2.1

Business Concentration- Prof. T. Das Sum=2.5 13
 2.7 CV and Var (Log)

(d) Coefficient of variation = 100 x SD /

AM where SD is the standard deviation
and AM is the arithmetic mean of
output of individual firms.
AM = Σ Qj/n, SD = √ (VAR),
VAR = Σ (Qj-AM)² /n
(e) Variance of logarithms- It is the
variance of the logarithms of outputs
of individual firms = Σ (log Qj– AML)² /
n
where AML = Σ log Qj/ n.
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 2.7-A Example of CV and Var
(Log)
Tj Pj Qj Q j x Q j ( T j- A M ) ^ 2lo g T j ( L n T j- A M L ) ^ 2
40 0 .2 0 .4 0 .16 0 4 00 3 .69 0.9 0
30 0 .2 0 .3 0 .09 0 1 00 3 .40 0.4 3
15 0 .2 0 .15 0 .02 3 25 2 .71 0.0 0
10 0 .2 0 .1 0 .01 0 1 00 2 .30 0.1 9
5 0 .2 0 .05 0 .00 3 2 25 1 .61 1.2 8
1 00 1 .0 1 .00 0 .28 5 8 50 1 3.7 2.8 1
AM = SD= C V = A M (L o gV) a r (l o g )
20 13 65 2 .74 0.5 6

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2.8 Lorenz Concentration Curve
and Gini-Lorenz ratio
(f) Gini-Lorenz ratio = 1 - Σ CPj(CQj+ CQi)
where i=j-1.

A Lorenz curve is the locus of all points

(CPj, CQj)
where CPj = Cumulative proportion of
units upto j-th firm arranged in ascending
order and CQj = Cumulative shares of
output of these firms.

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2.9 Lorenz Concentration Curve
and Gini-Lorenz ratio
Both CPj and CQj range in between 0
and 1. A Lorenz curve is drawn within a
unit-square box diagram. The 45 degree
radius vector is called the egalitarian line
as on it CPj equals CQi for each i=1, 2, 3
….. n. The area between the Lorenz
curve and the egalitarian line is called
the area of concentration (A).
Gini-Lorenz ratio equals the area of
concentration (A) divided by the area of the
triangle below the egalitarian line.

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2.10 Lorenz Concentration Curve

and Gini-Lorenz ratio- Industry-A

F ir m T u
Business Concentration- Prof. T. Das 18
2.11 Lorenz Concentration Curve

and Gini-Lorenz ratio-Industry-B

F ir m T u
Business Concentration- Prof. T. Das 19
2.12 LorenzConcentration
Curves

Business Concentration- Prof. T. Das 20

 2.13 Do the various ratios
satisfy characteristics of ideal
index?
Index F(Tj)? 1≥R≥ 0 Hom°? R(T+a)< Transfer
R(T) criteria?

CR No Yes Yes Yes Yes?

HHI Yes Yes Yes Yes Yes
HTI Yes Yes Yes Yes Yes
CV Yes No Yes Yes Yes
VarLog Yes No Yes Yes Yes

Gini Yes Yes Yes Yes Yes

Business Concentration- Prof. T. Das 21
 3.1 Industry-1

F ir m
Business Concentration- Prof. T. Das 22
3.2 Industry-2

Rj
1
Business Concentration- Prof. T. Das 23
3.3 Industry Comparisons

A
Business Concentration- Prof. T. Das
H
24
 4.1 Review Questions
1. Define Lerner’s index of monopoly power.
Discuss factors which determine monopoly
power in an industry.
2. What are the characteristics of an ideal
measure of business concentration? Define
concentration ratio, Herfindahl and
Hirschmann Index, and Hall and Tideman
Index of business concentration. Do they
satisfy characteristics of an ideal measure?
3. Define Lorenz curve and Gini Lorenz ratio.
Does it satisfy characteristics of an ideal
measure of business concentration.

Business Concentration- Prof. T. Das 25

 4.2 Review Questions
4. Five firms in a market have market shares of
25, 25, 25, 15 and 10 per cent respectively.
Calculate the Herfindahl-Hirschmann index,
Hall and Tideman index and concentration
ratios for top-3 (CR3) and top-4 (CR4) firms.
Suppose the smallest two firms propose to
merge. What would be the impact of such
merger on these concentration ratios? What
would be the Gini-Lorenz ratio after merger?
Is their any conflicts among the
concentration ratios after merger?

Business Concentration- Prof. T. Das 26

 4.2-A Answer for Q.4.2
B e fo r e M e r g e r
F i r mT u r n oPv reo r p So hr ta. rQe j x QR j x Q Cj P j C Q j P j x (C Q j
Rj Tj Pj Qj + C Q j-1 )
1 2 5 0 .2 0 .2 5 0 .0 6 3 0 .2 5 0 .2 0 0 .2 5 0 .0 5 0
2 2 5 0 .2 0 .2 5 0 .0 6 3 0 .5 0 0 .4 0 0 .5 0 0 .1 5 0
3 2 5 0 .2 0 .2 5 0 .0 6 3 0 .7 5 0 .6 0 0 .7 5 0 .2 5 0
4 1 5 0 .2 0 .1 5 0 .0 2 3 0 .6 0 0 .8 0 0 .9 0 0 .3 3 0
5 1 0 0 .2 0 .1 0 .0 1 0 0 .5 0 1 .0 0 1 .0 0 0 .3 8 0
T o ta l 1 0 0 1 .0 1 .0 0 0 .2 2 02 .6 0 0 1 .1 6 0
C R 3 C R 4 H H H T G in i
0 .7 5 0 .9 0 0 .2 2 0 .2 4 0 .1 6 0

Business Concentration- Prof. T. Das 27

 4.2-B Answer for Q4.2
A fte r M e r g e r
F i r mT u r n oP v r eo rpS ohr at . rQe j x RQ j x QCj P j C Q j P j x (C Q j
Rj Tj Pj Q j + C Q j-1 )
1 2 5 0 .2 5 0 .2 5 0 .0 6 3 0 .2 5 0 .2 5 0 .2 5 0 .0 6 3
2 2 5 0 .2 5 0 .2 5 0 .0 6 3 0 .5 0 0 .5 0 0 .5 0 0 .1 8 8
3 2 5 0 .2 5 0 .2 5 0 .0 6 3 0 .7 5 0 .7 5 0 .7 5 0 .3 1 3
4 2 5 0 .2 5 0 .2 5 0 .0 6 3 1 .0 0 1 .0 0 1 .0 0 0 .4 3 8
T o t a l 1 0 0 1 . 0 1 . 0 0 0 . 2 5 02 . 5 0 0 1 .0 0 0
C R 3 C R 4 H H H T G in i
0 .7 5 1 .0 0 0 .2 5 0 .2 5 0 .0 0 0

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 4.2-C There are conflicts among the
various ratios. CR3 remains unchanged.
CR4, HHI and HTI increase after merger.
But Gini ratio declines to zero after
merger and shows no concentration. Thus
while Gini-Lorenz ratio indicates degree of
dispersal, others indicate degree of
market power by dominant firms. CR and
Gini donot depend on number of firms
while HHI and HTI depend on number of
firms.
C R 3 C R 4 H H H T G in i
B e f o r e M0 e. 7r 5g 0e .r9 0 . 2 2 0 . 2 4 0 . 1 6
A f t e r M e 0r g. 7 e5 r 1 . 0 0 . 2 5 0 . 2 5 0

Business Concentration- Prof. T. Das 29

 Thank you
Have a Good Day

Business Concentration- Prof. T. Das 30