A2 Economics Notes

Definition 

• • Indicates the proportion of output generated by the largest firms in an industry. 

  • The concentration ratio does not have a fixed number of firms for its calculation. 

  • It provides an indication of the level of dominance and market control held by the leading firms in an industry. 

Example 

• • The Four-Firm Concentration Ratio measures the combined market share of the four largest firms within an industry.

  • For instance, if the CR4 of the automobile industry is 80%, it means that the four largest automakers control 80% of the total market share.

Usefulness

• Concentration ratios indicate the level of competition in an industry. 

• Higher concentration ratios suggest lower competition, while lower ratios indicate greater competition. 

• An industry is typically considered oligopolistic when the four largest firms control 40% of the output. (Do note: The 40% cutoff point is arbitrary and not inherently significant in concentration ratio analysis.) 

Limitations 

• They only reflect concentration within a national market and do not consider competition from abroad, potentially giving a misleading impression of concentration and competition. 

• Concentration ratios do not account for the global market position of firms, where they may have a strong presence despite competition in the domestic market. 

• They fail to consider competition from other industries, especially in the case of substitute goods, which can affect the overall concentration. 

• Concentration ratios do not differentiate between different sizes of the largest firms, which can lead to varying interpretations of market power.