Herfindahl-Hirschman Index

Definition

The Herfindahl-Hirschman Index (HHI) is a measure of market concentration used to assess the competitive landscape of an industry. It is calculated by summing the squares of the market shares of all firms in the industry, providing insight into how concentrated or fragmented a market is. A higher HHI indicates less competition and more monopoly power, while a lower HHI suggests a more competitive environment.

5 Must Know Facts For Your Next Test

1. The HHI ranges from 0 to 10,000, with 0 indicating a perfectly competitive market and 10,000 signifying a monopoly.
2. An HHI below 1,500 generally indicates a competitive market, while an HHI between 1,500 and 2,500 suggests moderate concentration, and above 2,500 indicates high concentration.
3. The HHI can help regulators evaluate mergers and acquisitions by assessing their potential impact on market competition.
4. Calculating the HHI involves squaring the market share of each firm (expressed as a percentage) and then summing these squares, making it sensitive to changes in market share.
5. The HHI is often used in conjunction with other metrics to provide a fuller picture of market structure and competitive dynamics.

Review Questions

• How does the Herfindahl-Hirschman Index help in evaluating the competitiveness of an industry?
  • The Herfindahl-Hirschman Index evaluates industry competitiveness by measuring market concentration through the sum of the squares of the market shares of all firms. A higher HHI indicates fewer firms dominate the market, suggesting less competition and potentially higher prices for consumers. In contrast, a lower HHI implies a larger number of smaller firms competing against each other, leading to more choices and better prices for consumers.
• Discuss the implications of a high Herfindahl-Hirschman Index for antitrust regulators when assessing mergers and acquisitions.
  • A high Herfindahl-Hirschman Index raises red flags for antitrust regulators because it indicates that the market is already concentrated. If two firms with significant market shares merge, the resulting increase in HHI may further reduce competition, leading to monopoly power that can harm consumers through higher prices and less innovation. Regulators may use the HHI as a critical metric to determine whether a proposed merger should be blocked or require conditions to mitigate its anti-competitive effects.
• Evaluate how changes in firm market shares can affect the Herfindahl-Hirschman Index and its interpretation regarding competition.
  • Changes in firm market shares directly impact the Herfindahl-Hirschman Index due to its squared calculations, meaning small shifts can lead to significant changes in HHI. For example, if a smaller firm gains market share at the expense of a larger competitor, the overall HHI may decrease, signaling increased competition. Conversely, if larger firms continue to consolidate their shares, even modest gains can cause a substantial rise in HHI, indicating reduced competition. This sensitivity underscores why regulators closely monitor shifts in market shares to maintain a healthy competitive environment.

Related terms

Market Share: The percentage of an industry's total sales that is controlled by a particular company or group of companies.

Concentration Ratio: A measure that indicates the total market share held by the largest firms in an industry, often used to gauge market power.

Antitrust Laws: Legislation designed to promote competition and prevent monopolistic practices by regulating anti-competitive behavior.