Herfindahl-Hirschman Index

Definition

The Herfindahl-Hirschman Index (HHI) is a measure of market concentration used to evaluate the level of competition within an industry. It is calculated by summing the squares of the market shares of all firms in the industry, which helps determine whether a market is monopolistic, oligopolistic, or competitive. A higher HHI indicates less competition and a greater likelihood of monopoly power, while a lower HHI suggests a more competitive market structure.

5 Must Know Facts For Your Next Test

1. The HHI ranges from 0 to 10,000; a score below 1,500 indicates a competitive market, 1,500 to 2,500 suggests moderate concentration, and above 2,500 indicates high concentration.
2. The index is sensitive to changes in market share; if one firm gains or loses market share, it can significantly impact the HHI.
3. Regulators often use the HHI when evaluating potential mergers and acquisitions to assess their impact on competition.
4. The HHI provides a more comprehensive view of market concentration compared to other measures like the concentration ratio, as it accounts for all firms in the market.
5. In many cases, an increase in the HHI after a merger may prompt regulatory scrutiny or intervention to maintain competitive markets.

Review Questions

• How does the Herfindahl-Hirschman Index help distinguish between different market structures like monopoly and oligopoly?
  • The Herfindahl-Hirschman Index distinguishes between different market structures by quantifying the level of concentration among firms. In a monopoly, the HHI would be very high since one firm dominates the entire market, while in an oligopoly, several firms hold significant market shares resulting in a moderate HHI. By analyzing the HHI value, one can gauge how many firms are active in the market and how concentrated their shares are, thus revealing whether the market leans toward monopoly or oligopoly.
• Discuss how antitrust authorities utilize the Herfindahl-Hirschman Index when assessing mergers and acquisitions.
  • Antitrust authorities utilize the Herfindahl-Hirschman Index to evaluate mergers and acquisitions by assessing how they affect market concentration. When two companies propose a merger, regulators calculate the HHI before and after the merger to determine if it significantly increases concentration. If the post-merger HHI exceeds certain thresholds indicating high concentration, authorities may investigate further or block the merger to preserve competition in the market.
• Evaluate the implications of a rising Herfindahl-Hirschman Index on consumer welfare and market efficiency.
  • A rising Herfindahl-Hirschman Index generally suggests decreasing competition within an industry, which can have adverse implications for consumer welfare and market efficiency. As fewer firms control greater shares of the market, they may raise prices or reduce product quality due to diminished competitive pressure. This leads to less innovation and reduced choices for consumers. Consequently, policymakers must monitor HHI trends closely to ensure that markets remain fair and competitive, ultimately protecting consumer interests.

Related terms

Market Concentration: The extent to which a small number of firms dominate total sales in a market, influencing pricing and supply.

Oligopoly:

A market structure characterized by a small number of firms that have significant market power and interdependent decision-making.

Antitrust Laws:

Legislation enacted to promote competition and prevent monopolistic practices, ensuring fair market conditions.