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Market Concentration:

Measurement and Trends


Firmansyah, S.E., M.Si., Ph.D
FEB UNDIP

Introduction
Analisis kompetisi perusahaan-perusahaan, mencakup
key-elements of industry structure
The most important characteristics of industry
structure include the number and size distribution of
rms, the existence and height of barriers to entry and
exit, and the degree of product differentiation
Seller concentration refers to the rst of these
elements: the number and size distribution of rms.
In empirical research in industrial organization, seller
concentration is probably the most widely used
indicator of industry structure

Markets and industries


The denition of a market is straight-forward in theory,
but often more problematic in practice.
Serviceable theoretical denitions can be found in the
works of the earliest, nineteenth-century economists.
The entire territory of which parts are so united by the
relations of unrestricted commerce that prices there take
the same level throughout, with ease and rapidity
(Cournot, 1838 pp. 512Fn).
prices of the same goods tend to equality with due
allowance for transportation costs (Marshall, 1920, p. 270)

For practical purposes, the denition of any market


contains both a product dimension and a geographic
dimension

The product market denition should include all products that are
close substitutes for one another, both in consumption and in
production.
Goods 1 and 2 are substitutes in consumption if an increase in the
price of Good 2 causes consumers to switch from Good 2 to Good
1.
The degree of consumer substitution between Goods 1 and 2 can
be measured using the cross-price elasticity of demand
Good 1s elasticity of demand with respect to a change in the price
of Good 2 is:

A large and positive cross-price elasticity of demand indicates that the two goods in
question are close substitutes in consumption (for example, butter and margarine).

In contrast, a large and negative cross-price elasticity of demand indicates that the
two goods are close complements (for example, camera and lm). However, this
could also imply that they should be considered part of the same industry. CD
players and ampliers might be grouped together as part of the hi- equipment
industry. But what about cars and petrol? These goods are also complementary,
but would it be sensible to include motor manufacturers and oil companies in the
same industry group?
Good 1 produced by rm A, and Good 2 produced with similar technology by rm
B are substitutes in production if an increase in the price of Good 1 causes rm B
to switch production from Good 2 to Good 1.
In this case, rms A and B are close competitors, even if from a consumers
perspective Goods 1 and 2 are not close substitutes. For example, Good 1 might be
cars and Good 2 might be military tanks.
No consumer would decide to buy a tank simply because there has been an
increase in the price of cars. But on receiving the same price decide to switch to
car production.
The degree of producer substitution between Goods 1 and 2 can be measured
using the cross-price elasticity of supply. Good 1s elasticity of supply with respect
to a change in the price of Good 2 is: signal, a tank producer might decide to
switch to car production. The degree of producer substitution between Goods 1
and 2 can be measured using the cross-price elasticity of supply.
Good 1s elasticity of supply with respect to a change in the price of Good 2 is:

The geographic market denition involves


determining whether an increase in the price
of a product in one geographic location
signicantly affects either the demand or
supply, and therefore the price, in another
geographic location. If so, then both locations
should be considered part of the same
geographic market. In principle, a similar
analysis involving spatial cross-price
elasticities could be used

Official schemes for industry


classification
The International Standard Industrial Classification of
All Economic Activities is a United Nations system for
classifying economic data. The United Nations Statistics
Division describes it in the following terms:
Wide use has been made of ISIC, both nationally and
internationally, in classifying data according to kind of
economic activity in the fields of production, employment,
gross domestic product and other statistical areas. ISIC is a
basic tool for studying economic phenomena, fostering
international comparability of data, providing guidance for
the development of national classifications and for
promoting the development of sound national statistical
systems.

ISIC Indonesia
kbli_2009.pdf

Measures of concentration
Seller concentration, an indicator of the
number and size distribution of rms, can be
measured at two levels:
1) for all rms that form part of an economy,
located within some specic geographical
boundary;
2) for all rms classied as members of some
industry or market, again located within some
specic geographical boundary.

The rst type of seller concentration, known as aggregate


concentration, reects the importance of the largest rms in the
economy as a whole
Typically, aggregate concentration is measured as the share of the n
largest rms in the total sales, assets or employment (or other
appropriate size measure) for the economy as a whole
The number of rms included might be n = 50, 100, 200 or 500
Aggregate concentration might be important for several reasons:
if aggregate concentration is high, this might have implications for
levels of seller concentration in particular industries;
aggregate concentration data might reveal information about the
economic importance of large diversied rms, which is not
adequately reected in indicators of seller concentration for particular
industries;
if aggregate concentration is high, this might indicate that the
economys largest rms have opportunities to exert a disproportionate
degree of inuence over politicians or regulators, which might render
the political system vulnerable to abuse

The second type of seller concentration,


known as industry concentration or
(alternatively) market concentration, reects
the importance of the largest rms in some
particular industry or market

economists have employed a number of alternative concentration


measures at industry level. To assist users in making an informed
choice between the alternatives that are available, Hannah and Kay
(1977) suggest a number of general criteria that any specic
concentration measure should satisfy if it is to adequately reect
the most important characteristics of the rm size distribution:
Suppose industries A and B have equal numbers of rms. Industry A
should be rated as more highly concentrated than industry B if the
rms cumulative market share (when the rms are ranked in
descending order of size) is greater for industry A than for industry B
at all points in the size distribution.
A transfer of market share from a smaller to a larger rm should
always increase concentration.
There should be a market share threshold such that if a new rm
enters the industry with a market share below the threshold,
concentration is reduced. Similarly, if an incumbent rm with a market
share below the threshold exits from the industry, concentration is
increased.
Any merger between two incumbent rms should always increase
concentration.

As will be shown below, not all of the seller


concentration measures that are in use satisfy
all of the Hannah and Kay criteria. This section
examines the construction and interpretation
of the most common measures of seller
concentration. These arethe n-rm
concentration ratio, the HerndahlHirschman
index, the Hannah-Kay index, the entropy
coefcient, the variance of the logarithms of
rm sizes, and the Gini coefcient.

Concentration Ratio

HerfindahlHirschman (HH) index

Hannah and Kay index


Hannah and Kay (1977)suggest the following generalization of the HH index:

where is a parameter to be selected. should be greater than zero, but not


equal to one, because HK(1) = 1 for any rm size distribution

The last two points are illustrated in Table 6.8. For I1 the contribution to the HK(1.5)
index of rm 1 (the largest rm) is 45.8 per cent (0.2003 out of 0.4376). But rm 1s
contribution to the HK(2.5) index is 63.8 per cent (0.0686 out of 0.1076). Our earlier
comments about the favourable properties of the HH index apply in equal measure to
the HK() index. Furthermore, the larger the value of , the smaller the degree of
inaccuracy if the HK() index is calculated using accurate individual data for the largest
rms, but estimated data for the smaller rms.

Entropy coefficient

E is an inverse concentration measure: E is small for a highly concentrated


industry, and E is large for an industry with low concentration
In Tables 6.5 and 6.6, E is 1.3721 (for I4), 1.7855 (I1) and 1.8236 (I5).
Therefore E correctly identies I4 as more concentrated than I1, and I1 as
more concentrated than I5
The minimum possible value is E = 0, for an industry comprising a single
monopoly producer. The maximum possible value is E = loge(N), for an industry
comprising N equal-sized rms

Standardized entropy coefcient, whose maximum value does


not depend on the number of rms (RE)

The minimum possible value is RE = 0 for a monopoly, and the maximum possible
value is RE = 1 for an industry comprising N equal-sized rms.

Variance of the logarithms of firm sizes


In statistics, a variance provides a standard measure of dispersion
or inequality within any data set. In the case of data on the sizes of
rms in an industry, the statistical property of dispersion or
inequality is closely related to (but not identical to) the economic
property of seller concentration.
In Table 6.5, dispersion in I2 is zero (because all rm sizes are the
same), but dispersion in I4 is much higher (due to the inequality in
the rm size distribution). Clearly, seller concentration is higher in I4
than in I2. Accordingly, the variance of the logarithms of rm sizes,
VL, can be included among the list of concentration measures
(Aitchison and Brown, 1966).
VL is dened as follows:

For the purposes of calculating VL, the rm size data are expressed in logarithmic form
for the following reasons:
Most industries have a highly skewed rm size distribution, with large numbers of
small rms, fewer medium-sized rms and very few large rms. The variance of the
(untransformed) rm size data would therefore tend to be unduly inuenced by the
data for the largest rms. The log-transformation reduces or eliminates the skewness
in the original distribution, enabling VL to provide a more reasonable measure of
inequality across the entire rm size distribution.
The variance of the (untransformed) rm size data would be inuenced by the scaling
or units of measurement of the data. VL, in contrast, is unaffected by scaling. For
example, if ination caused the reported sales data of all rms to increase by 10 per
cent, the variance of the (untransformed) sales data would increase, but VL would be
unaffected. In this case, there is no change in concentration or dispersion because the
sales of all rms are increased in the same proportions. VL reects this situation
accurately.

Although VL has occasionally been used as a measure of seller concentration,


it is more accurate to interpret VL as a measure of dispersion or inequality in
the rm size distribution. The distinction can be illustrated using the following
examples taken from Tables 6.5 and 6.6:
Both I2 and I3 have VL = 0 because in both cases all rms are equal-sized, so
there is no inequality. From an industrial organization perspective, however, it
seems clear that I3 is more highly concentrated than I2. I3 has fewer rms
than I2, making it more likely that a cooperative or collusive outcome will be
achieved.
An economist would regard I6 as more concentrated than I1. However, the
merger between the three smallest rms in I1 to form I6 implies I6 has a lower
degree of inequality in its rm size distribution than I1. Accordingly VL is
smaller for I6 than for I1. When we switch from I1 to I6, VL moves in the
opposite direction to HH and HK(), and in the wrong direction from the
economists perspective.

Lorenz curve and the Gini coefficient


A Lorenz curve (named after Lorenz, 1905) shows the variation in the
cumulative size of the n largest rms in an industry, as n varies from 1 to N
(where N is the total number of rms)

The rms are represented in a horizontal array, from


the largest to the smallest (reading from left to right)
along the horizontal axis. The vertical axis shows the
cumulative size (the sum of the sizes of all rms from
rm 1 to rm n, as a function of n)
If all of the rms are equal-sized, the Lorenz curve is the
45-degree line OCA. At point C, for example, exactly half of
the industrys member rms account for exactly half of the
total industry size, represented by the distance OD.
If the rm size distribution is skewed, the Lorenz curve is
the concave curve OBA. At point B, exactly half of the
industrys member rms account for three-quarters of the
total industry size, represented by OD.

The Lorenz curve can be used to dene a concentration measure due to Gini (1912),
known as the Gini coefcient. With reference to Figure 6.1, the Gini coefcient is
dened as follows:

The maximum possible value of G = 1 corresponds to the case of one dominant


rm with a market share approaching one, and N 1 very small rms each with
a negligible market share. In this case the Lorenz curve approaches the line ODA,
so the numerator and denominator in the formula for G are the same.
The minimum value of G = 0 corresponds to the case of N equal-sized rms. In
this case the Lorenz curve is the 45-degree line OCA, so the numerator in the
formula for G is zero.
The formula denition for the Gini coefcient is as follows:
where xi is the size of rm i (as before,
measured using sales, assets, employment or
some other appropriate size indicator) when
the rms ranked in descending order of size

Like the variance of logarithmic rm sizes measure, the Gini


coefcient is most accurately interpreted as a measure of
inequality in the rm size distribution. In fact, elsewhere in
economics one of the best known applications of the Gini
coefcient is for the measurement of inequality in household
incomes. In our case, Tables 6.5 and 6.6 show that both I2 and I3
have G = 0, because in both cases all of the rms are equal-sized.
As before, however, an industrial economist might regard I3 as
more highly concentrated than I2. Furthermore, I6 has G =
0.3129, smaller than G = 0.4482 for I1. But an industrial
economist would regard I6 as more concentrated than I1.