Which of the following four-firm concentration ratios would be the best indicator of an oligopoly?

In economics, a concentration ratio refers to the ratio of the market shares of a particular company in relation to the entire market size. This ratio also measures the size of a company or firm in comparison to the size of the whole market. Analysts often consider the 3-firm, 4-firm, 5-firm and 8-firm concentration ratio. CR and the CR, are the most common concentration ratios, while CR refers to the market share of the four largest firms in the market, the CR, means the market share of the eight largest firms.

Back to:ECONOMIC ANALYSIS & MONETARY POLICY

How to use the Concentration Ratio?

The concentration ratio is an important determinant of whether a particular market or industry of monopolistic, oligopolistic or there is healthy competition among firms. It describes the extent at which few large firms control the market or industry. For instance, if the concentration ratio of one company is almost at 100%, it indicates that such company is the only visible company and operates a monopoly. Low concentration ratio by all firms on the other hand means competition exists in the market. If a four-firm concentration ratio is used, it means the market share of the four largest firms are compared to the entire market or industry.

Concentration Ratio Formula and Interpretation

Whether a CR, CR, 3-firm and 5-firm concentration ratios is used, it is important to know that these formulas have one thing in common. They are calculated as the percentage of the total market shares held by the firms in relation to the value of the entire industry. Typically, a concentration ratio ranges from 0% - 100%, this ratio gives an insight to the level of competition that exists in a market. This means it is also possible an competition to be absent in an industry. Low concentration ratio indicates greater competition in the industry, a ratio between 0% to 50% means the industry is perfectly competitive. The industry however has a oligopolistic tendency when four or five largest firms account for more than 60% of the market share. When only one company has 100% concentration ratio, a monopoly exists.

Example Calculation

The illustration below will enhance a rapt understanding of how concentration ratio works; Assuming that companies ABC, LMN, PQR, and XYZ are the largest for companies in an industry, if the aggregate of the market shares of the companies is 80%, with the companies having (30% 15% 18% and 17%) respectively, it means the industry is an oligopoly. If the four companies have less than 60% as the aggregate market share, that means competition exists in the market. A perfectly competitive industry is attained when there is a concentration ratio of 0% to 50%.

Herfindahl-Herschman Index

While the concentration ratio serves as an indicator of the size of a firm and the competitiveness of an industry, there is an alternative indicator. The Herfindahl-Herschman Index is also used to measure the size of a firm by squaring the percentage share of each firm in the industry and summing it up to arrive at an HHI. The HHI is often regarded as a better indicator of the level of concentration in a market.

Related Topics

• Perfect Competition
• Market Power
• Price Takers
• Price Makers (Pricing Power)

The concentration ratio, in economics, is a ratio that indicates the size of firms in relation to their industry as a whole. Low concentration ratio in an industry would indicate greater competition among the firms in that industry, compared to one with a ratio nearing 100%, which would be evident in an industry characterized by a true monopoly.

• The concentration ratio compares the size of firms in relation to their industry as a whole.
• Low concentration ratio indicates greater competition in an industry, compared to one with a ratio nearing 100%, which would be a monopoly.
• An oligopoly is apparent when the top five firms in the market account for more than 60% of total market sales, according to the concentration ratio.

The concentration ratio indicates whether an industry is comprised of a few large firms or many small firms. The four-firm concentration ratio, which consists of the market share of the four largest firms in an industry, expressed as a percentage, is a commonly used concentration ratio. Similar to the four-firm concentration ratio, the eight-firm concentration ratio is calculated for the market share of the eight largest firms in an industry. The three-firm and five-firm are two more concentration ratios that can be used.

The concentration ratio is calculated as the sum of the market share percentage held by the largest specified number of firms in an industry. The concentration ratio ranges from 0% to 100%, and an industry's concentration ratio indicates the degree of competition in the industry. A concentration ratio that ranges from 0% to 50% may indicate that the industry is perfectly competitive and is considered a low concentration.

A rule of thumb is that an oligopoly exists when the top five firms in the market account for more than 60% of total market sales. If the concentration ratio of one company is equal to 100%, this indicates that the industry is a monopoly.

Assume that ABC Inc., XYZ Corp., GHI Inc., and JKL Corp. are the four largest companies in the biotechnology industry, and an economist aims to calculate the degree of competition. For the most recent fiscal year, ABC Inc., XYZ Corp., GHI Inc., and JKL Corp. have market shares of 10%, 15%, 26%, and 33%, respectively. Consequently, the biotech industry's four-firm concentration ratio is 84%. Therefore, the ratio indicates that the biotech industry is an oligopoly. The same could be calculated for more or less than four of the top companies in the industry. The concentration ratio only indicates the competitiveness of the industry and whether an industry follows an oligopolistic market structure.

The Herfindahl-Herschman Index (HHI) is an alternative indicator of firm size, calculated by squaring the percentage share (stated as a whole number) of each firm in an industry, then summing these squared market shares to derive an HHI. The HHI has a fair amount of correlation to the concentration ratio and can be a better measure of market concentration.