Review about

Concentration: measurement and trends

Alyaa Putri Kusuma

C1G019029
IESP International

UNIVERSITAS JENDERAL SOEDIRMAN

FAKULTAS EKONOMI DAN BISNIS
2021
1. Introduction
Usually, the most important characteristics of industry structure include the
number and size distribution of firms, the existence and height of barriers to entry and
exit, and the degree of product differentiation. Seller concentration refers to the first of
these elements: the number and size distribution of firms. In empirical research in
industrial organization, seller concentration is probably the most widely used indicator
of industry structure. Any specific seller concentration measure aims to reflect the
implications of the number and size distribution of firms in the industry for the nature
of competition, using a relatively simple numerical indicator.
Before producing concentration measures for specific markets or industries, it
is necessary to take decisions concerning the boundaries of the markets or industries
that are being measured. Individual size data are available for the firms that are
members of the industry. The concentration or inequality measures include the n-firm
concentration ratio, the Herfindahl– Hirschman index, the entropy coefficient and the
Gini coefficient. Worked examples are used to illustrate the method of calculation for
each measure, and to compare the properties and limitations of the various measures.

2. Literature Review
a. Market Definition
The definition of the relevant market is likely to be a crucial decision.
The definition of a market is straightforward in theory, but often more
problematic in practice. Serviceable theoretical definitions can be found in the
works of the earliest nineteenth-century economists. For practical purposes, the
definition of any market contains both a product dimension and a geographic
dimension. The product market definition 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 is measured using the cross-price elasticity
of demand.
A large and positive cross-price elasticity of demand indicates that the
two goods are close substitutes in consumption (for example, butter and
margarine). If the price of Good 2 rises, the demand for Good 1 also rises. Goods
1 and 2 should therefore be considered part of the same industry.
 In contrast, a large and negative cross-price elasticity of demand
indicates that the two goods are close complements (for example, personal
computer and printer). However, this could also imply that they should be
considered part of the same industry. Compact disc players and speakers might
be grouped together as part of the consumer electronics industry.
The geographic market definition involves determining whether an
increase in the price of a product in one geographic location significantly 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 to determine the geographic limits of market
boundaries.

b. Industry Definition
The term ‘industry’ will usually refer to a group of firms producing and
selling a similar product, using similar technology and perhaps obtaining factors
of production from the same factor markets. A focus on factor markets might
provide a yardstick for grouping firms into industries that differs from the
criteria for market definition discussed above. However, once again there are
practical difficulties. This type of classification might suggest that soap and
margarine belong to the same industry, while woollen gloves and leather gloves
belong to different industries.

c. Industry Classification
Although in principle the definition of markets and industries may raise
a number of difficult issues, for the practical purpose of compiling official
production and employment statistics, some specific scheme for defining and
classifying industries is required. In 1992, the European Commission
introduced the current classification system that is used throughout the
European Union (EU), known as Nomenclature générale des activités
économiques dans les communautés Européennes (NACE). At the same time,
the UK’s Standard Industrial Classification (SIC), originally introduced in 1948
and revised in 1980, was revised to achieve consistency with NACE. The
objective was to standardise industry definitions across member states, making
 inter-country comparisons easier and providing a statistical basis for the
harmonization of competition and industrial policy within the EU. The UK’s
1992 SIC (SIC 1992) is based on a four-digit numbering system, while NACE
adds a fifth digit in some cases. There are 17 sections, labelled alphabetically
from A to Q. These are reproduced in Table 10.1, which provides a comparison
with the earlier SIC 1980.
Although there is consistency between the industry definitions used in
the UK’s SIC 1992 system and the EU’s NACE system, there are minor
differences in the numerical presentation of the various levels of both systems.
For example, NACE contains more levels in total than SIC 1992. Most of the
NACE sections are subdivided into subsections by the addition of a second letter.

d. Measures of seller concentration

Seller concentration, an indicator of the number and size distribution of firms,
can be measured at two levels:
1. For all firms that form part of an economy, located within some specific
geographical boundary.
2. For all firms classified as members of some industry or market, again
located within some specific geographical boundary.
The first type of seller concentration, known as aggregate concentration,
reflects the importance of the largest firms in the economy as a whole. Although
in practice data are relatively hard to come by, in principle aggregate
concentration is relatively straightforward to measure. Typically, aggregate
concentration is measured as the share of the n largest firms in the total sales,
assets or employment (or other appropriate size measure) for the economy as a
whole. The number of firms 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 diversified firms, which is not adequately
reflected in indicators of seller concentration for particular industries.
  If aggregate concentration is high, this might indicate that the
economy’s largest firms have opportunities to exert a disproportionate
degree of influence over politicians or regulators, which might render
the political system vulnerable to abuse, or the regulation system
vulnerable to regulatory capture

The second type of seller concentration, known as industry concentration or

market concentration, reflects the importance of the largest firms in some
particular industry or market. In some cases, it may also be relevant to measure
buyer concentration, in order to assess the importance of the largest buyers. This
might arise in the case of an industry which supplies a specialised producer good,
for which the market includes only a very small number of buyers.

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 specific concentration measure should satisfy if it is to
adequately reflect the most important characteristics of the firm size
distribution:

 Suppose industries A and B have equal numbers of firms. Industry

A should be rated as more highly concentrated than industry B if the
firms’ cumulative market share (when the firms 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 firm should
always increase concentration.
 There should be a market share threshold such that if a new firm
enters the industry with a market share below the threshold,
concentration is reduced. Similarly, if an incumbent firm with a
market share below the threshold exits from the industry,
concentration is increased.
 Any merger between two incumbent firms should always increase
concentration.
 As 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 are the n-firm concentration ratio, the Herfindahl–
Hirschman index, the Hannah Kay index, the entropy coefficient, the variance
of the logarithms of firm sizes and the Gini coefficient.

e. n-firm concentration ratio

The n-firm concentration ratio, usually denoted CRn, measures the share
of the industry’s n largest firms in some measure of total industry size. The most
widely used size measures are based on sales, assets or employment data. The
formula for the n-firm concentration ratio is as follows:
𝑛

𝐶𝑅𝑛 ∑ 𝑆𝑖
𝑖=1

Where S1 is the share of the i-th largest firm in total industry sales,
assets or employment.
These comparisons show that the n-firm concentration ratio fails to meet
several of the Hannah and Kay criteria for a satisfactory concentration measure.
For example, a transfer of sales from a smaller to a larger firm does not
necessarily cause CRn to increase; and a merger between two or more industry
member firms does not necessarily cause CRn to increase.
f. Herfindahl-Hirschman (HH) index
Working independently, both Hirschman (1945) and Herfindahl (1950)
suggested a concentration measure based on the sum of the squared market
shares of all firms in the industry. The Herfindahl–Hirschman (HH) index is
calculated as follows:
𝑁
2
HH = ∑ 𝑆
𝑖
𝑖=1

Where si is the market share of firm i, and N is the total number of firms
in the industry. For an industry that consists of a single monopoly producer, HH
2
= 1. A monopolist has a market share of S1 = 1. Therefore 𝑠 1 = 1, ensuring HH

= 1. For an industry with N firms, the maximum possible value of the

 Herfindahl-Hirschman index is HH = 1, and the minimum possible value is HH
= 1/N.
g. Hannah and Kay index
It is possible to interpret the Herfindahl–Hirschman index as a weighted sum
of the market shares of all firms in the industry, with the market shares
themselves used as weights. A general expression for a weighted sum of
market shares is
𝑁

∑ 𝑤𝑖𝑠𝑖
𝑖=1

Where wi denotes the weight attached to firm i. setting wi = Si reproduces the

Herfindahl-Hirschman index :
𝑁 𝑁
2
HH = ∑ 𝑤𝑖𝑠𝑖 ∑ 𝑆
𝑖
𝑖=1 𝑖=1
The numbers equivalent can be defined for any value of a that is greater than
zero apart from a = 1. The properties and interpretation of the numbers
equivalent are the same as before. For an industry with N firms, the minimum
value is 1 (one dominant firm and N - 1 small firms); and the maximum value
is N (all N firms are equal-sized). In Tables 10.4 and 10.5, n(α) = 9 for I2 (with
N = 9 equal-sized firms) and n(α) = 6 for I3 (with N = 6 equal-sized firms), no
matter what value is chosen for α.
3. Conclusion
Seller concentration, the number and size distribution of firms in an industry, is
one of the key characteristics of industry structure. Chapter 10 has examined the
measurement of seller concentration. Any specific measure aims to reflect the
implications of the number of firms and their size distribution for competition in the
industry concerned.
In measuring seller concentration for any industry or market, it is necessary to
take decisions concerning industry or market definition. The definition of any market
contains both a product dimension and a geographic dimension. The product market
definition should include all products that are close substitutes for one another, both in
consumption and in production. The geographic market definition involves determining
whether an increase in the price of a product in one location significantly affects
demand or supply elsewhere. Price and cross-price elasticities can be used to determine
 the limits of product and geographic market boundaries. In practice, however,
substitution is always a matter of degree, and decisions concerning boundaries are
always arbitrary to some extent. The UK’s Standard Industrial Classification and
NACE, its EU counterpart, are currently the official standard used in the compilation
of government statistics.
The most widely used seller concentration measures include the n-firm
concentration ratio, the Herfindahl–Hirschman index, the Hannah–Kay index, the
entropy coefficient, the variance of the logarithms of firm sizes, and the Gini coefficient.
The method of calculation for all of these measures has been described in detail, and
their strengths and limitations have been assessed.

4. References
Materi bab 10 di Eldiru