The concentration ratio is a measure of the degree to which an industry or sector is controlled by a small number of firms. It is calculated as the sum of the market share of the largest firms in an industry or sector divided by the total market share. The concentration ratio is often used to gauge the level of competition within an industry or sector.
A high concentration ratio indicates that a small number of firms control a large proportion of the market and may be indicative of oligopoly, where there are few firms and each has a significant impact on price and output decisions. A low concentration ratio indicates that there are many firms in the market and each has a relatively small impact on price and output decisions. Highly concentrated industries tend to be less competitive than those with a low concentration ratio.
There are a few different ways to calculate the concentration ratio. The most common method is to add together the market share of the largest firms in an industry or sector and divide by the total market share. This gives the concentration ratio for the entire industry or sector.
Another way to calculate the concentration ratio is to look at each firm individually and compare its market share to the total market size. This gives the concentration ratio for each firm. The advantage of this method is that it allows you to see how each firm compares to the others in terms of market share.
The disadvantage of using the concentration ratio is that it doesn’t take into account the number of firms in an industry or sector. For example, an industry with two equally sized firms would have a concentration ratio of 50%, even though there are only two firms in the market.
The Herfindahl-Hirschman Index (HHI) is another way to measure the degree of concentration in an industry or sector. It takes into account both the number of firms and their market share. The HHI is calculated by squaring the market share of each firm and then adding together all of the squared values. The resulting number is then divided by the total market size.
The advantage of using the HHI is that it gives a more accurate picture of the level of competition within an industry or sector. The disadvantage is that it is more complicated to calculate than the concentration ratio.