As I have discussed in previous posts, the models of perfect competition and monopoly produce very different outcomes for productive and allocative efficiency. Perfect competition produces a good allocation of resources and, but a monopoly results in a deadweight loss. In the real-world economy it is not quite so simple. In particular, not every market is readily classified as following either of these extreme models. Indeed, you might think that the majority of the markets do no correspond to either of these models, but instead display a mixture of characteristics.
An important question is whether such markets behave more like a competitive market or more like a monopoly. There are many different ways in which markets with just a few firms operating can be modelled, because there are many ways in which the firms may interact. Some of these models will be explained in later posts.
It is helpful to have some way of gauging how close a particular market is to being a monopoly. One way of dong this is to examine the degree of concentration in the market. Later it will be seen that this is not all that is required to determine how efficiently a market will operate; but it is a start.
Concentration ratio is normally measured by reference to concentration ratio, which measures the market share of the largest firms in the industry. For example, the three-firm concentration ratio measures the market share of the largest three firms. Concentration can also be viewed in terms of employment, reflecting the proportion of workers in any industry that are employed by the largest firms.
Consider the following example. The table below gives average circulation figures for the firms that publish national newspapers in the UK. In the final column these are converted in to market shares. Where one firm produces more than one newspaper their circulations have been combined.
|Firm||Average circulation||Market share (%)|
|News International Newspapers Ltd||3,470,711||36.3|
|Associated Newspapers Ltd||2,077,545||21.7|
|Trinity Mirror plc||1,318,168||13.8|
|Express Newspapers Ltd||1,292,330||13.5|
|Telegraph Group Ltd||799,021||8.4|
|Guardian Newspapers Ltd||292,909||3.1|
|Independant Newspapers Ltd||178,576||1.9|
|Financial Times Ltd||130,695||1.4|
The three-firm concentration ratio is the sum of the market shares of the three largest firms, that is 36.3 + 21.7 + 13.8 = 71.8%.
Concentration ratios may be calculated on the basis of either shares in output or shares in employment. In the above example, the calculation was on the basis of output (daily circulation). The two measures may give different results, because the largest firms in an industry may be more capital intensive in their production methods, which means their share of the input in an industry will be smaller than their share of the output.
Thus might seem an intuitively simple measure, but it is too simple to enable an evaluation of a market. For a start, it is important to define the market appropriately: for instance, in the above example are the Financial Times and the Sun really part of the same market?
The five-firm concentration ratio of various industrial sectors varies from 14.1% in tools to 99.6% in tobacco. In part, the difference between sectors may be expected to reflect the economies of scale, and this makes sense for many industries.