Measuring Market Power

How economists measure how concentrated an industry is and how much power firms have over prices, including market shares and the HHI.

Competition authorities and economists often need to judge how much market power firms have: their ability to raise prices above costs without losing too many customers. Several tools help measure this.

Market shares and concentration ratios

The simplest measure is market share: each firm’s share of total sales. A concentration ratio adds up the shares of the largest firms, such as the top four. A four-firm ratio of 90 percent suggests a highly concentrated market.

The Herfindahl-Hirschman Index

A widely used measure is the Herfindahl-Hirschman Index, or HHI. It is calculated by squaring each firm’s market share, in percent, and adding them up.

A market with one firm has an HHI of 10,000, since 100 squared is 10,000.
A market with 100 equal firms has a very low HHI.

Squaring gives more weight to larger firms. Competition authorities in the United States use HHI thresholds when reviewing mergers; markets above 1,800 have been treated as highly concentrated in recent guidelines.

Markups

Market power shows up in markups: the ratio of price to marginal cost. Research by Jan De Loecker, Jan Eeckhout and Gabriel Unger found that average markups of U.S. public companies rose substantially from 1980 onward, prompting debate about whether market power has increased.

Calculating HHI

A market has three firms with shares of 50, 30 and 20 percent. The HHI is 50 squared plus 30 squared plus 20 squared: 2,500 plus 900 plus 400, which equals 3,800. This indicates a highly concentrated market. If the two smaller firms merged, the HHI would rise to 50 squared plus 50 squared, or 5,000.

Defining the market

All these measures depend on how the market is defined. Is the market “cola drinks”, “soft drinks” or “all beverages”? A narrow definition makes firms look more dominant. Competition authorities spend much effort defining markets, often by asking what products customers would switch to if prices rose.

Thinking high market share always means abuse

A firm may have a large market share because it offers better products or lower prices. Market power becomes a concern mainly when it is used to raise prices, reduce quality or exclude competitors.

Key takeaways

Market power is the ability to raise prices above costs without losing many customers.
Concentration ratios and the HHI measure how concentrated a market is.
Markups compare prices with marginal costs, and research found U.S. markups rose after 1980.
All measures depend on how the market is defined.