Four Firm Concentration Ratio

A way to get an idea of the sizes of the competing firms in the market is through the use of the four-firm concentration ratio. We can infer from the name that the four firm concentration ratio is calculated by getting the ratio of the output of the four largest firms to the total output of the industry. In a market where competitors are roughly the same size, the market’s four firm concentration ratio would be low. Conversely, in a market where there are dominant players, the four firm concentration would be much higher.

For an industry with 20 competitors, a concentration ratio of 30% is quite low. In a perfectly competitive market, the 20 competitors would have equal market share. This would give us a four firm concentration ratio of 4/20 which is 20%. The 30% concentration ratio cited gives us a picture of a market that does not deviate much from an industry with perfect competition. The state of near perfect competition tells us that this market is a market operating under monopolistic competition.

Upon a price hike, all firms will benefit nearly equally in this type of market. Because there are no firms which dominate the market, all players can be expected to move the same amount of product. There are also no firms in a position to dictate the price through price leadership, to gouge consumers or to undercut the other sellers. As again, this is because all firms are of the same relative size. Because the firms cannot influence the pricing of the product, the product’s price will be dictated by supply and demand and as such will tend to remain at or near equilibrium price.

While a market with 30% concentration ratio can be qualified as operating under monopolistic competition, a market with 80% concentration ratio can already be called an oligopoly. This is because only a small part of the market (20%) is responsible for 80% of the market’s production. The other 16 firms only account for 20% of the market’s production. Such figures show the dominant position the four leading firms have in the market.

A key reason for the existence and sustenance of oligopolies are high barriers to entry.  Barriers to entry prohibit the entry of additional firms to compete with the dominant players. We may look at the ease of starting up a new car repair shop (which have no dominant players) to starting a new automobile company (a market with marked dominant firms). Because of the barriers to entry, established firms can continue to strengthen their dominant position over time.

It may seem foolhardy for a small firm to operate in an oligopoly controlled market. And yet, there are still cases where small firms are able to operate and survive alongside their oligopolist competitors. One way that these small firms are able to operate is by trying to serve niche markets – smaller markets which the large firms may overlook. Czech company Jablotron manufactured a cell phone especially made for the elderly. Jablotron can never approach the size and breadth of Nokia or Motorola – the dominant players in the cellphone market but by targeting the elderly, Jablotron is able to effectively operate in a mini market with no dominant competitors. Another example is the social networking market dominated by the likes of NewsCorp owned MySpace and billion dollar valued Facebook. Yet there are still new and upcoming social networking markets which dont compete against Facebook by targeting niche markets. These include OUTEverywhere (for the gay niche market) and aSmallWorld (jet-set elite market).

Bibliography

Mankiw, Gregory. Principles of Economics. 12th . Mason, OH: Thomson Higher Education, 2007.