Concentration Ratio

What Is Concentration Ratio?

The concentration ratio, in economics, is a ratio that shows the size of firms corresponding to their industry as a whole. Low concentration ratio in an industry would demonstrate greater competition among the firms in that industry, compared to one with a ratio approaching 100%, which would be clear in an industry portrayed by a true monopoly.

Figuring out the Concentration Ratio

The concentration ratio shows whether an industry is included a couple of large firms or many small firms. The four-firm concentration ratio, which comprises of the market share of the four largest firms in an industry, communicated as a percentage, is a usually utilized concentration ratio. Like 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 utilized.

Concentration Ratio Formula and Interpretation

The concentration ratio is calculated as the sum of the market share percentage held by the largest determined number of firms in an industry. The concentration ratio goes from 0% to 100%, and an industry's concentration ratio shows the degree of competition in the industry. A concentration ratio that reaches from 0% to half might show that the industry is perfectly competitive and is viewed as a low concentration.

A rule of thumb is that a oligopoly exists when the best five firms in the market account for over 60% of total market sales. Assuming the concentration ratio of one company is equivalent to 100%, this demonstrates that the industry is a monopoly.

Model Calculation

Assume that ABC Inc., XYZ Corp., GHI Inc., and JKL Corp. are the four largest companies in the biotechnology industry, and an economist plans to compute the degree of competition. For the latest fiscal year, ABC Inc., XYZ Corp., GHI Inc., and JKL Corp. have market shares of 10%, 15%, 26%, and 33%, separately. Thusly, the biotech industry's four-firm concentration ratio is 84%. Subsequently, the ratio demonstrates that the biotech industry is an oligopoly. The equivalent could be calculated for pretty much than four of the top companies in the industry. The concentration ratio just demonstrates the competitiveness of the industry and whether an industry follows an oligopolistic market structure.

Herfindahl-Herschman Index

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 determine a HHI. The HHI has a fair amount of correlation to the concentration ratio and can be a better measure of market concentration.

Features

• An oligopoly is apparent when the best five firms in the market account for over 60% of total market sales, as per the concentration ratio.
• The concentration ratio compares the size of firms corresponding to their industry as a whole.
• Low concentration ratio shows greater competition in an industry, compared to one with a ratio approaching 100%, which would be a monopoly.