Herfindahl-Hirschman Index

Definition

The Herfindahl-Hirschman Index (HHI) is a measure of market concentration used to assess the competitiveness of an industry. It is calculated by summing the squares of the market shares of all firms in the industry, with higher values indicating less competition and greater market power held by a few firms. The HHI helps in understanding how concentrated an industry is and can influence regulatory decisions regarding mergers and acquisitions.

5 Must Know Facts For Your Next Test

1. The HHI ranges from 0 to 10,000, with lower values indicating a more competitive market and higher values suggesting a less competitive market.
2. An HHI below 1,500 indicates a competitive marketplace, while an index between 1,500 and 2,500 suggests moderate concentration, and above 2,500 indicates high concentration.
3. The HHI is particularly useful in antitrust assessments, helping regulators evaluate potential anti-competitive effects of mergers and acquisitions.
4. To calculate the HHI, you square each firm's market share (expressed as a percentage), then sum these values across all firms in the market.
5. Changes in HHI can indicate shifts in industry dynamics, such as increased consolidation or the emergence of new competitors.

Review Questions

• How does the Herfindahl-Hirschman Index help in understanding the competitive dynamics within an industry?
  • The Herfindahl-Hirschman Index provides a quantitative measure of market concentration by calculating the sum of the squares of market shares held by all firms in an industry. This allows analysts to assess how competitive or concentrated an industry is. A lower HHI indicates many small competitors, while a higher HHI points to dominance by a few firms, which can impact pricing and consumer choice.
• Discuss the implications of a high Herfindahl-Hirschman Index for regulators considering a merger between two large firms.
  • A high Herfindahl-Hirschman Index suggests that an industry is already concentrated, meaning that adding another significant player through a merger could further diminish competition. Regulators would be concerned that such consolidation could lead to higher prices, reduced innovation, and fewer choices for consumers. Consequently, they may scrutinize the merger more closely or impose conditions to maintain competition.
• Evaluate how shifts in the Herfindahl-Hirschman Index over time can reflect changes in industry structure and competition levels.
  • Shifts in the Herfindahl-Hirschman Index over time can indicate significant changes within an industry’s structure, such as increased consolidation through mergers or the entrance of new competitors. For instance, if the HHI increases due to mergers among dominant firms, it suggests growing market power and reduced competition. Conversely, if new entrants lead to a declining HHI, it indicates enhanced competition and possibly lower prices for consumers. Analyzing these shifts helps stakeholders understand evolving market dynamics and make informed strategic decisions.

Related terms

Market Concentration: The degree to which a small number of firms dominate total industry sales or production.

Monopoly: A market structure where a single firm controls the entire market for a product or service, leading to high prices and limited choices for consumers.

Oligopoly: A market structure characterized by a small number of firms that have significant market power, often leading to competitive behavior and strategic interactions among them.