What advantages does a herfindahl-type index have as a measure of Essay

What advantages does a herfindahl-type index have as a measure of industrial concentration over an n firm concentration ratio - Essay Example There are two main differences of the Herfindahl index with the concentration ratio. The Herfindahl index uses all the firms market shares rather than using any particular number of the largest firms and furthermore, it uses the squares of the values of the market shares to compute the extent of concentration. So,if we assume N firms in the industry, the Herfindahl index looks like: To identify the relative advantages of the Herfindahl type index it is pertinent to note the desirable properties such competitiveness indices should exhibit. First, any competitiveness index should exhibit a decreasing trend with a rising number of firms. This is simply a reflection of the fact that as the number of firms increases the competitiveness rises and hence any index that captures the extent of concentration in the industry should reduce in value (Tirole, 1988). Secondly, any index of concentration should also be non-increasing if not declining with an increase in the extent of symmetry in the market shares of the associated firms (Tirole, 1988). Thus, having perceived the basic features any adequate index of concentration should have, we now proceed to comparatively analyse the two aforementioned measures in the extents they meet up to these requirements. Evidently, the concentration ratio as well as the Herfindahl index both satisfies the first requirement. Both of the indices shall exhibit declining trends as the number of firms start rising since the individual market shares as a percentage of the total market output shall fall. However, the concentration ratio fails to satisfy the second requirement. If there was a redistribution of market shares among the considered firms with some of them gaining higher market shares while that of the others fell so that the total market share of these firms taken together remained the same, the concentration ratio would not change. However, in the Herfindahl index, the squared values of the individual market