A2 Economics – Concentration Ratio

Part of the CIE A2 syllabus deals with the concentration ratio and by good fortune a recent edition of The Economist schools brief looked at this area.

The concentration ratio is the percentage of market share taken up by the largest firms. It could be a 3 firm concentration ratio (market share of 3 biggest) or 5 firms concentration ratio. Concentration ratios are used to determine the market structure and competitiveness of the market. The most commonly used are 4, 5 or 8 firm concentration ratios which measure the proportion of the market’s output provided by the largest 4, 5 or 8 firms.

Example of a hypothetical concentration ratio
The following are the annual sales, in $m, of the six firms in a hypothetical market:

Firm A = 56
Firm B = 43
Firm C = 22
Firm D = 12
Firm E = 3
Firm F = 1

In this hypothetical case, the 3-firm concentration ratio is 88.3%, that is 121/137 x 100.

According to the OECD, member countries between 2000 and 2014 experienced an increase in concentration ratios. The share of sales accounted for by the top eight firms in a given industry in the EU and North American were as follows:

Some policy makers are unconcerned with industrial concentration as it doesn’t tell you how competitive the market is for a particular good. Although others have blamed falling levels of competition, the stagnant labour markets and growing inequality. Add to that low interest rates and weak investment the rising power of companies has been increasing.

However one could argue that those firms which have high concentrations (especially in the technology sector) have also been very productive. The internet has broken down barriers to entry into markets and enabled firms to deliver goods and services in a very convenient manner at lower prices to a vast consumer market. But although this sounds encouraging there are barriers to new firms entering into this medium:

  • a new firm will require masses of data to tailor their services to individual users
  • other firms already in the market can see what preferences consumers have and because they already have a client base they can easily provide similar products/services.
  • established firms already in the market can buy out new entrants – Facebook bought Instagram and WhatsApp. Between 2009-2019 technology firms made over 400 acquisitions with little interference from regulators.

Source: The Economist – Economics brief – Competition. 8th August 2020