Herfindahl

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The Herfindahl index (also known as Herfindahl–Hirschman Index, or HHI) is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them. Named after economists Orris C. Herfindahl and Albert O. Hirschman, it is an economic concept widely applied in competition law, antitrust and also technology management. It is defined as the sum of the squares of the market shares of the 50 largest firms (or summed over all the firms if there are fewer than 50) within the industry, where the market shares are expressed as fractions. The result is proportional to the average market share, weighted by market share. As such, it can range from 0 to 1.0, moving from a huge number of very small firms to a single monopolistic producer. Increases in the Herfindahl index generally indicate a decrease in competition and an increase of Export marketing or market power, whereas decreases indicate the opposite.


The major benefit of the Herfindahl index in relationship to such measures as the concentration ratio is that it gives more weight to larger firms.


The measure is essentially equivalent to the Simpson diversity index used in ecology.


Intuition

When all the firms in an industry have equal market shares, H = 1/N. The Herfindahl is correlated with the number of firms in an industry because its lower bound when there are N firms is 1/N. An industry with 3 firms cannot have a lower Herfindahl than an industry with 20 firms when firms have equal market shares. But as market shares of the 20-firm industry diverge from equality the Herfindahl can exceed that of the equal-market-share 3-firm industry (e.g., if one firm has 81% of the market and the remaining 19 have 1% each H=0.658). A higher Herfindahl signifies a less competitive industry.



References:

1.http://en.wikipedia.org/wiki/Herfindahl_index



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