Oligopoly refers to the state of market wherein a couple of comparatively big companies get concentrated, meaning a few but big companies are responsible for most of the total amount produced. Oligopoly concentration by itself is not essentially bad but is often the cause unhealthy business practices like no competition on the basis of prices and complicity of businesses. There are three ways to measure Oligopoly concentration: ratio of concentration, market share and Herfindahl index.
Concentration is the key characteristic of oligopoly. If the market for a product is monopolized, concentration is not really applicable. In case of perfect competition there are many small companies and concentration can hardly be measured.
Oligopoly concentration comprises of a couple of big companies that produce most of the production for any given product. As such, production as well sales of product has a propensity of getting concentrated among a couple of companies. In case of a lot of oligopoly markets, more than 75 percent of business is in hands of the ten biggest companies. It is this kind of concentration that contributes to interesting characteristics of oligopoly like near elimination of competition on basis of price and business collusion.
Oligopoly concentration can be measured in one of thee three ways:
- Market Share: The simplest way to measure concentration is to assess the market share of one of the companies. Most often, it is measured as a part of the total sales or production of that company. For instance, total sales of soft drinks in Shady Valley may be $ 2,000 million, whereas OmniCola sells worth $460. That means market share of OmniCola is 23 percent.
- Ratio of concentration: In this case, market concentration is calculated by the market shares of the biggest number of companies in an industry. In most cases of concentration ratios, there are four or eight biggest companies in one industry. For instance, in case of market for soft drinks in Shady Valley, four firms at the top have sales of $470 million, $360 million, $235 million, and $200 million respectively whereas the total market for cold drink is estimated to be $2 billion. That means concentration of four companies is to the extent of nearly 61 percent. More expressly, ratio of concentration is a fraction of the total sales of all the manufacturers. The results of concentration ratio vary from 0-100 percent.
- Herfindahl Index: To overcome some of the limitations of concentration ratios, this index was developed. In case of four or eight firm concentration ratios, the goings-on of companies not included in calculation get ignored. Herfindahl Index takes into consideration the market share of all companies present in the market. Another feature of this index is that instead of just adding the market share, it squares up every market share before addition. As a result, Herfindahl Index gives values from 0 to 10,000.
Whenever questions are raised about likely violation of antitrust laws, government officials first check the ratio of concentration. When concentration is efficient or good, it becomes easy to abuse market control.