The Herfindahl-Hirschman index is one of the main indicators by which we can distinguish between the markets of pure monopoly, oligopoly, monopolistic and perfect competition. It shows how many companies are represented in a particular market segment, what is the share of their products.
Formula for determining the index
The Herfindahl-Hirschman index formula has the following form: HHI = S 1 2 + S 2 2 + … + S n 2, where S 1 2 and S 2 2 is the squared percentage of the company's goods and services in a particular industry. This part is defined as the ratio of producer sales in the market to the entire volume of goods or services in this industry. The obtained value should be in the range between 1 and 10000. An indicator of 10000 means a complete monopolization of the economic sector by one company.
The Herfindahl-Hirschman Index shows the level of concentration in the industry. It should be noted that this parameter is closely related to the Lerner power monopoly coefficient. In addition, it should be emphasized that HHI is an effective indicator of changes in the market share of a company. He is also able to indirectly indicate the amount of economic profit obtained through the use of monopoly power.
The above formula makes it possible to delimit the impact on HHI of the number of companies in the industry and the division of the market between them. Provided that all manufacturers control the same parts of the industry, the scatter will be zero. Then the HHI value is inversely related to the number of companies on the market. At the same time, with a fixed number of manufacturers, HHI increases with the difference between the parts of firms in the industry.
Index usage
As already mentioned, the Herfindahl-Hirschman index indicates the level of monopolization of a particular sector of the economy. It is widely used by the US Department of Justice to analyze upcoming merger transactions. In addition, since 1982, HHI has been the basic parameter that is used in America to implement antitrust policy by the state. The fundamental advantage of the index is the ability to clearly demonstrate the redistribution of parts of the industry between different companies.
The Herfindahl-Hirschman Index as a Way to Combat Monopolies
When analyzing the index, the level of concentration in the industry is estimated. In practice, this means that the closer the market to monopoly, the lower the level of competition and higher concentration. We give an example. If the industry is entirely occupied by one company, then HHI will be equal to 10, 000, since this company has a 100% market share. In this case, obviously, we are talking about a monopoly.
On the other hand, if a thousand companies are represented in a particular industry, the market share of each of which tends to zero, then the index will also be close to zero. This, in turn, indicates the existence of almost perfect competition in the industry. In accordance with the methodology used by the US Department of Justice, an industry with a Herfindahl-Hirschman index of less than 1000 is considered competitive. If the HHI value is between 1000 and 1800, then the market is moderately concentrated. An indicator in excess of 1800 indicates a high concentration in the economic sector.
