Oligopoly: The Real World

Economic concentration measures the control that the largest firms have of a particular economic activity in a region of the world, an economy, a sector of an economy, or an industry. The presumption is that competition and concentration are negative/y related. 

Aggregate economic concentration measures concentration beyond traditional industry lines. It is most often used to measure the share of economic activity undertaken by the largest firms in a major sector of an economy, but sometimes it is used in the context of a whole economy or even a region of the world.

Aggregate economic concentration does not focus on competing firms. The interest in aggregate concentration stems from the belief that the economic and political advantages gained through size alone may enable a firm to control those particular industries in which it is involved. 

Market concentration measures the control by the leading firms within a group of competing firms. 

To help solve the problem of defining industries or markets (the group of competing firms), the U.S. government has designed an elaborate classification system called the Standard Industrial Classification (SIC). This system divides the out puts of firms into groups beginning with a small number of broad, two-digit major industry groups and ending with a large number of narrow, seven digit products.

Market concentration levels may be measured by traditional 4-firm and 8-firm concentration ratios or by calculating Herfindahl-Hirshman Indexes (HHls), which take account of all the firms in a market and the distribution of their market shares.

The U.S. concentration ratios that are published by the Bureau of the Census may be quite revealing, but should be viewed with caution as they may contain some serious overstatements and  understatements of concentration in actual industries. These may result from: (1) too broad or narrow a definition of the industry product, (2) the omission of foreign competition, and (3) the use of national rather than regional or local geographic scope.

High levels of economic concentration may be reached by firms growing either internally through building or ->externally through merger. Economists usually favor internal growth because it must be accomplished in the face of competition. 

Mergers are of three different types: horizontal, vertical, and conglomerate In a horizontal merger a firm acquires another firm engaged in the same activity, existing on the same level, and serving the same geographic market. In a vertical merger a firm acquires another firm that is either in a buyer or a seller relationship to it. In a conglomerate merger a firm acquires another firm engaged in a different industry. Conglomerate mergers are further broken down into product extension, geographic market extension, and relatively pure conglomeration.

There have been four fairly distinct merger movements in the United States. The first took place around the turn of the century and was largely horizontal. The second came just after World War I and was again primarily horizontal, though some vertical and conglomerate mergers also took place. The third merger wave came in the late 1960s and was predominantly conglomerate in nature. The latest merger movement began in the mid- 1970s and continued into the very late 198Os. It is composed primarily of conglomerate and horizontal mergers.

Firms often prefer merger to internal growth for the following reasons: (a) It may be the quickest way to expand plant capacity. (b) It may be the lowest-cost way to grow or the easiest to finance. (c) It may be the lowest-risk way to diversify. (d) It may be a way to capture speculative gains. (e) It may best suit the personal goals of managers as distinct from owners of the firm. (f) It may increase a firm's monopoly control by eliminating a competitor or a potential competitor.

An important determinant of the degree of monopoly control in an industry is the likelihood of entry into that industry. Entry, as defined in economics, requires an addition to industrial capacity plus the addition of a new firm to an industry. Just as interdependence exists between the established firms in an oligopolistic industry, interdependence also exists between those established firms and potential entrants.

Some industries are harder to enter than others. A measure of the "condition of entry" is the extent to which established firms are able to charge high prices and earn economic profit without attracting new firms into their industry.

An industry's condition of entry depends on the type and height of the barriers to entry in that industry. There are four kinds of barriers: (a) capital requirements, (b) product differentiation, (c) absolute-cost differences, and (d) minimum optimal scale effect.

The capital-requirement barrier is determined by the amount of money that an entrant must have in order to acquire the plant, equipment, and other things that it needs to compete with established firms. The product-differentiation barrier is caused by established firms ability to differentiate their products and thus gain consumer acceptance, which is difficult for an entrant to overcome. The absolute- cost barrier exists when established firms in an industry experience lower average total cost than an entrant can achieve. Finally, the minimum optimal scale effect barrier relates to how much an industry's price will be depressed by the additional output supplied by an entrant operating at minimum optimal scale.