Concentration Ratio

Economics, Microeconomics

Year 3

Four-Firm Concentration Ratio

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Solution

Concentration ratios are calculated based on the market shares of the largest firms in the industry.

An industry with 20 firms and the CR = 30% is called "Low Concentration", for a concentration ratio of 0 to 50 percent is commonly interpreted as low concentration. The industry is monopolistically competitive and that the four largest firms have very moderate market control.

When the demand for the product rises and pushes up the price for the good. Then in the short run, the existing 20 firms will make positive profit and become better off. The short-run equilibrium will be reached where marginal cost equals marginal revenue, i.e. profit maximizing.

However, In the long-run firms are able to change the scale of product and enter or leave the industry. New firms will also enter the industry to take advantage of the profit, and the total supply will be increased, which will press the market price down to the long-run equilibrium price (= the minimum LR average cost).

On the other hand, since this industry is monopolistically competitive, each firm has some power of price setting. They will compete for market share by charging a price lower than any other producers. This is called Bertrant Game, which will end in a lot of firms charging the long-run equilibrium price. At this point there is no incentive to entry and equilibrium is established

This adjustment process implies the relationship between CR and the properties of the industry. When CR is low, monopolistic competition occurs and the market exhibits elements of both perfect competition and monopoly. And the lower the CR, the more competitive the market. As shown in this posting, the low CR will wipe out the temporary price increase, and drive the economy back to long run equilibrium level, a characteristic like competitive market.

For a concentration ratio of 80 to 100 percent is viewed as high concentration. Government regulators are usually most concerned with industries falling into this category. It is a good indication of oligopoly and that these four firms have significant market control.

*What are some reasons why this industry has a high CR while the other industry has a low CR?

In industrialized countries, high CR industries are found in many sectors of the economy, such as cars, consumer goods, and steel production.

For example, the aircraft industry has a CR close to 80%. There are now only a small number of manufacturers of civil passenger aircraft. This is due to economy return to scale: the initial investment of an aircraft manufacturer or an air company is extremely high, usually involving billions of dollars. Then it is practically impossible for small firms to enter this market, although there is obviously high profit in the industry. This initial investment works like a capital barrier to entrants, and caused high CR.

Another important reason arises in a heavily regulated market such as wireless communications. Typically the country will license only two or three providers of cellular phone services. Obviously, this is due to national security issue. Another industry: Cigarettes has a CR of 93%, which shows the government's intention to control for harmful commodities.

*IS it possible for smaller firm to thrive and profit in such an industry? How?

It is still possible for smaller firm to thrive and profit in such an industry.

The oligopolists are producing similar, but not exactly, the same products, so all of them are facing elastic (downward sloping) demand curve. This casts a light on the smaller firms' strategies in marketing decision. They should also differentiate products