Herfindahl-Hirschman Index (HHI)

Definition

The Herfindahl-Hirschman Index (HHI) is a measure of market concentration calculated by squaring the market share of each firm competing in a market and then summing the resulting values. This index is widely used to assess the potential anti-competitive effects of mergers and acquisitions, as it provides insight into the level of competition in an industry. A higher HHI indicates a more concentrated market, which can lead to increased scrutiny from regulatory bodies during merger evaluations.

5 Must Know Facts For Your Next Test

1. The HHI ranges from 0 to 10,000, where lower values indicate a more competitive market and higher values suggest greater concentration.
2. An HHI below 1,500 typically indicates a competitive marketplace, while an HHI between 1,500 and 2,500 signifies moderate concentration, and above 2,500 indicates high concentration.
3. Regulatory agencies, like the Federal Trade Commission (FTC), often use the HHI to evaluate proposed mergers and assess their impact on market competition.
4. A significant increase in HHI after a merger may raise red flags for regulators who are concerned about potential monopolistic behavior.
5. The HHI helps predict how mergers could affect pricing and output decisions within an industry, making it a vital tool for economic analysis.

Review Questions

• How does the Herfindahl-Hirschman Index help in evaluating the competitive impact of mergers?
  • The Herfindahl-Hirschman Index helps in evaluating the competitive impact of mergers by quantifying market concentration before and after the merger. By calculating the HHI, regulators can see how much the merger would increase concentration in the market. If the post-merger HHI is significantly higher than pre-merger levels, it raises concerns about potential anti-competitive behavior, prompting further investigation into whether the merger should be allowed.
• Discuss the implications of having an HHI above 2,500 for firms considering a merger.
  • Having an HHI above 2,500 indicates high market concentration and suggests that any further mergers could lead to reduced competition. For firms considering a merger in such a concentrated market, this could mean facing significant regulatory hurdles. They may have to provide strong justifications for how the merger will benefit consumers or lead to efficiencies that outweigh anti-competitive concerns. Otherwise, there is a substantial risk that regulatory bodies will block the merger.
• Evaluate how changes in market share among top firms can influence the Herfindahl-Hirschman Index and overall market dynamics.
  • Changes in market share among top firms can significantly influence the Herfindahl-Hirschman Index by altering market concentration levels. If a dominant firm loses market share to competitors, the HHI will decrease, suggesting increased competition and potentially leading to more favorable conditions for consumers. Conversely, if one firm grows substantially at the expense of others, the HHI will rise, indicating reduced competition. This shift can affect pricing strategies, investment decisions, and innovation within the industry as firms react to their changing competitive environment.

Related terms

Market Concentration: The degree to which a small number of firms dominate total sales in a market, often assessed using various metrics including HHI.

Antitrust Laws: Legislation designed to promote competition and prevent monopolistic practices that can harm consumers and the economy.

Market Share: The percentage of total sales in a market that is controlled by a particular company, crucial for calculating the HHI.