The concentration of firms in an industry is of interest to economists, business strategists, and government agencies. Here, we discuss two commonly-used methods of measuring industry concentration: the Concentration Ratio and the Herfindahl-Hirschman Index. Concentration Ratio (CR) The concentration ratio is the percentage of market share owned by the largest m firms in an industry, where m is a specified number of firms, often 4, but sometimes a larger or smaller number. The concentration ratio often is expressed as CRm, for example, CR4. The concentration ratio can be expressed as: CRm  =  s1  +  s2  +  s3  +  … … +  sm where  si  =  market share of the ith firm. If the CR4 were close to zero, this value would indicate an extremely competitive industry since the four largest firms would not have any significant market share. In general, if the CR4 measure is less than about 40 (indicating that the four largest firms own less than 40% of the market), then the industry is considered to be very competitive, with a number of other firms competing, but none owning a very large chunk of the market. On the other extreme, if the CR1 measure is more than about 90, that one firm that controls more than 90% of the market is effectively a monopoly. While useful, the concentration ratio presents an incomplete picture of the concentration of…

Game theory analyzes strategic interactions in which the outcome of one’s choices depends upon the choices of others. For a situation to be considered a game, there must be at least two rational players who take into account one another’s actions when formulating their own strategies. If one does not consider the actions of other players, then the problem becomes one of standard decision analysis, and one is likely to arrive at a strategy that is not optimal. For example, a company that reduces prices to increase sales and therefore increase profit may lose money if other players respond with price cuts. As another example, consider a risk averse company that makes its decisions by maximizing its minimum payoff (maxmin strategy) without considering the reactions of its opponents. In such a case, the minimum payoff might be one that would not have occurred anyway because the opponent might never find it optimal to implement a strategy that would make it come about. In many situations, it is crucial to consider the moves of one’s opponent(s). Game theory assumes that one has opponents who are adjusting their strategies according to what they believe everybody else is doing. The exact level of…

Auctions are mechanisms for determining prices. Auctions often are classified as one of the following auction types:  First-price sealed-bid auction – winner pays his bid. In this case, one should bid below one’s value an amount that depends on how many other bidders there are. The more bidders, the closer to one’s value that one should bid. There is a tradeoff between profit and the frequency of winning.    Second-price sealed-bid auction – winner pays highest losing bid. In this type of auction, the optimal strategy is to bid one’s value.  English auction – auctioneer begins with a low price. Bidders raise their bids until nobody is willing to bid higher. The optimal strategy in an English auction is to bid up to one’s value, staying in the auction until the bids exceed one’s value.  Dutch auction – auctioneer calls out prices beginning with a very high value and gradually reduces it. The first bidder to accept an offered price wins. The Dutch auction gets its name because of its use in the flower markets in Holland. Note that eBay defines Dutch auctions differently. On eBay, a Dutch auction is one in which there are multiple units of the same…

Economic growth is measured in terms of an increase in the size of a nation’s economy. A broad measure of an economy’s size is its output. The most widely-used measure of economic output is the Gross Domestic Product (abbreviated GDP). GDP generally is defined as the market value of the goods and services produced by a country. One way to calculate a nation’s GDP is to sum all expenditures in the country. This method is known as the expenditure approach and is described below.   Expenditure Approach to Calculating GDP The expenditure approach calculates GDP by summing the four possible types of expenditures as follows: GDP    =   Consumption    +  Investment    +  Government Purchases    +  Net Exports Consumption is the largest component of the GDP. In the U.S., the largest and most stable component of consumption is services. Consumption is calculated by adding durable and non-durable goods and services expenditures. It is unaffected by the estimated value of imported goods. Investment includes investment in fixed assets and increases in inventory. Government purchases are equal to the government expenditures less government transfer payments (welfare, unemployment payouts, etc.) Net exports are exports minus imports. Imports are subtracted since GDP…

The most commonly reported measure of the consumer price levels in the United States is the Consumer Price Index (CPI). Published by the U.S. Department of Labor ‘s Bureau of Labor Statistics, the CPI is a fixed-weight price index using a fixed basket of goods that are representative of what a typical consumer purchases each month. There are many different CPI’s calculated by region, types of products, types of consumers, etc. The most commonly reported CPI is the CPI-U, which is the CPI for all urban consumers. Increases in the CPI level serve as a measure of the consumer inflation rate. The rate of inflation over a period of time is simply the percentage increase in the CPI over the period, often reported on an annualized basis. Uses of the CPI The CPI has many important uses, including the following: Economic indicator – the CPI is the most commonly reported measure of consumer prices. Reference for escalation agreements – labor contracts and other payment agreements that are indexed to inflation rely on the CPI. Deflator for economic series – when a series of data is to be adjusted so that it is reported in constant dollars, the CPI often is…

Economic growth is not a steady phenomenon; rather, it tends to exhibit a pattern as follows: an expansion of above-average growth a peak a contraction of below-average growth a trough or low-point The troughs then are followed by periods of expansion and the cycle generally repeats, though not in a regular manner. These fluctuations in economic growth are known as the business cycle and are depicted conceptually in the following diagram:   The Business Cycle   Indicators of the Business Cycle Because the business cycle is related to aggregate economic activity, a popular indicator of the business cycle in the U.S. is the Gross Domestic Product (GDP). The financial media generally considers two consecutive quarters of negative GDP growth to indicate a recession. Used as such, the GDP is a quick and simple indicator of economic contractions. However, the National Bureau of Economic Research (NBER) weighs GDP relatively low as a primary business cycle indicator because GDP is subject to frequent revision and it is reported only on a quarterly basis (the business cycle is tracked on a monthly basis). The NBER relies primarily on indicators such as the following: employment personal income industrial production Additionally, indicators such as manufacturing…

The percentage of the labor force that is seeking a job but does not have one is known as the unemployment rate. The unemployment rate is defined as follows: Unemployed Workers     x   100%   Employed  +  Unemployed Workers Unemployed workers are those who are jobless, seeking a job, and ready to work if they find a job. The sum of the employed and unemployed workers represent the total labor force. Note that the labor force does not include the jobless who are not seeking work, such as full-time students, homemakers, and retirees. They are considered to be outside the labor force. The labor force participation rate is the percentage of the adult population that is part of the total labor force. All of these measures consider only persons 16 years of age or older. The movement among the three groups can be illustrated as shown in the following diagram.   Model of Labor Force Movement       Employed                Unemployed       Not in the     Labor Force    The diagram shows seven possible movements: Employed  to  Employed  –  an employed person moves directly from one job to another job. Employed  to  Unemployed  –  an employed person moves to unemployed status either…