Herfindahl-Hirschman Index

Definition

The Herfindahl-Hirschman Index (HHI) is a measure of market concentration used to assess the level of competition within an industry. It is calculated by summing the squares of the market shares of all firms in the market, with a higher HHI indicating less competition and a more concentrated market structure. The HHI helps policymakers and economists evaluate the competitive landscape and identify potential antitrust concerns.

5 Must Know Facts For Your Next Test

1. The Herfindahl-Hirschman Index ranges from 0 to 10,000, where lower values (below 1,500) indicate a competitive market and higher values (above 2,500) indicate high concentration.
2. HHI is often used by regulatory agencies, such as the Federal Trade Commission, to assess mergers and acquisitions for potential anti-competitive effects.
3. An HHI of 1,000 or below suggests a highly competitive market, while an HHI between 1,000 and 1,800 indicates moderate concentration.
4. In an industry with many small firms, the HHI will be low, while in industries dominated by a few large companies, the HHI will be significantly higher.
5. The calculation of HHI can reveal shifts in market structure over time, helping analysts track changes in competition due to new entrants or exits in the market.

Review Questions

• How does the Herfindahl-Hirschman Index contribute to understanding market competition?
  • The Herfindahl-Hirschman Index provides a quantitative measure of market concentration that helps assess the level of competition within an industry. By summing the squares of market shares, the HHI reveals whether an industry is competitive or dominated by a few large firms. A higher HHI indicates less competition and potential monopolistic behavior, while a lower HHI suggests a more competitive environment where multiple firms have similar market power.
• Discuss how policymakers use the Herfindahl-Hirschman Index in evaluating mergers and acquisitions.
  • Policymakers utilize the Herfindahl-Hirschman Index to evaluate potential mergers and acquisitions by analyzing the combined market shares of merging firms. A significant increase in HHI post-merger may indicate that the merger could lead to excessive market concentration and reduce competition. Therefore, regulatory agencies assess whether the proposed merger would violate antitrust laws or harm consumers by creating monopolistic conditions in the affected market.
• Evaluate the implications of high Herfindahl-Hirschman Index values on consumer choice and pricing strategies within an industry.
  • High Herfindahl-Hirschman Index values imply that an industry is highly concentrated, which can significantly limit consumer choice and lead to higher prices. In such markets, a few dominant firms may have the power to influence prices without fear of losing customers to competitors. This lack of competition can result in reduced innovation, inferior products, and overall dissatisfaction among consumers as their options become restricted. Analyzing HHI values can therefore inform discussions on regulatory interventions aimed at promoting competition and protecting consumer interests.

Related terms

Market Concentration: Market concentration refers to the degree to which a small number of firms control a large portion of the market share in an industry.

Antitrust Laws: Antitrust laws are regulations designed to promote competition and prevent monopolistic practices within markets.

Oligopoly: An oligopoly is a market structure characterized by a small number of firms that have significant market power and influence over prices.