Lesson 8 of 8 · 11 min
Identifying market structure: elasticity, concentration ratios and HHI
Market power is best judged by estimating demand elasticity, but because that is hard, analysts and regulators use the concentration ratio and the Herfindahl-Hirschman index, both of which ignore the threat of entry.
In short
- Market power lets firms restrict output and raise prices, so competition (antitrust) law limits it; analysts should consider whether regulators may block a merger.
- In theory, measure power through elasticity: very elastic demand suggests near-perfect competition. Estimation is hard (endogeneity, data needs, structural change).
- N-firm concentration ratio: sum of the market shares of the largest N firms. Simple, but barely reacts to mergers among the top firms and ignores entry.
- HHI: sum of the squared market shares of the top N firms. It reacts more strongly to mergers; 1/HHI is the equivalent number of equal-sized firms.
- Neither measure accounts for the threat of entry or the elasticity of demand.
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