The major benefit of the Herfindahl index in relationship to such measures as the concentration ratio is that it gives more weight to larger firms. Take, for instance, two cases in which the six largest firms produce 90 percent of the output:
We will assume that the remaining 10% of output is divided among 10 equally sized producers.
The six-firm concentration ratio would equal 90 percent for both case 1 and case 2, but in the first case competition would be fierce where the second case approaches monopoly. The Herfindahl index for these two situations makes the lack of competition in the second case strikingly clear:
This behavior rests in the fact that the market shares are squared prior to being summed, giving additional weight to firms with larger size.
The United States uses the Herfindahl index to determine whether mergers are equitable to society; increases of over 100 points generally provoke scrutiny, although this varies from case to case. The Department of Justice considers Herfindahl indices between 1000 and 1800 to be moderately concentrated and indices above 1800 to be concentrated. As the market concentration increases, competition and efficiency decrease and the chances of collusion and monopoly increase.
See also: Concentration ratio, Market forms, Mergers, Microeconomics
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