Concentration ratios

Measuring the degree of competition

We can get some indication of how competitive a market is by observing the number of firms: the more firms, the more competitive the market would seem to day. However, this does not tell us anything about how concentrated a market might be. There may be many firms suggesting a situation close to perfect competition or monopolistic competition, but then just two firms might produce 95 per cent of total output. This would make these two firms more like oligopolists.

Thus even though a large number producers may make the market seem highly-competitive, this could be deceiving. Another approach, therefore, to measuring the degree of competition is to focus on the level of concentration.

The simplest measure of industrial concentration is by adding together the market share of the largest so many firms: e.g. the largest three or the largest five. This would give what is known as the 3-firm or 5-firm concentration ratio.

The table below shows the 5-firm concentration ratios of selected industries in the UK. As you can see, there’s an enormous variation in the degree of concentration from one industry to another.

One of the main reasons for this is the differences in the percentage of total industry and put at which economies of scale are exhausted. If this occurs at in a level of airport, they will be room for smoke several firms in the industry which war or all benefiting from the Max Mekong is a scale. Take the case of tufted carpets. Economies of scale are exhausted at less than one per cent of total industry output. It is not surprising the largest five firms under a carpet industry are cared for any 21.8 per cent of output. In the case deal, however, the minimum efficient plants eyes at 72 per cent of industry output, the largest five firms account for 95.3 per cent of a report by most of which is produced by one firm British Steel differences in the extent of economies of scale are not the only cause of differences in concentration. The degree of concentration will also depend on the barriers to entry of other firms into the industry and on various factors such as transport costs and a historical accident. It will also depend on how very the products are within any one industry category. For example, in categories as large as ‘clothing’ and ‘toys and sports goods’ there is room for many firms, each producing a specialised range of products. With each sub-category e.g. tennis rackets, there may be relatively few firms producing.

So is the degree of concentration a good guide to degree of competitiveness of the industry? The answer is that it is some guide, but on its own can be misleading. In particular, it ignores degree of competition from abroad, and from other areas within the country. Thus the five largest UK motor vehicle manufacturers may produce 82.9 per cent of UK vehicle output, but these manufacturers face considerable competition from imported cars and lorries. On the other hand, the five largest water suppliers may account for only 49.7 per cent of UK output, but within their own regions of the country they have a monopoly.

Questions

1. What are the advantages and disadvantages of using a five firm concentration ratio rather than a 10-firm, a 3- firm or even a ratio?

2. Why are some industries like bread-making and brewing relatively concentrated, in that a few firms producing large proportion of total output are, and yet there are also many small producers?