The four-firm concentration ratio is used in economics as an indicator to the relative market share held by the four largest firms in an industry. Depending on the percentage held by those four firms, one can draw conclusions about the state of the market and the level of competition within the industry. Industries with concentration ratios of near 100% are said to be monopolies. In contrast, those with ratios that are very low (less than 10%) are said to represent an industry with a perfect competition where no firm has the power to influence market prices.
An industry with 20 firms and a concentration ratio of 20% represents an industry where there is no significant firm that has influence over the prices of commodities but there is a degree of control for some in the industry. There is balanced competition and the opportunity for all firms to benefit and be profitable and there are few barriers to entry into the industry or exit from it. This is called a monopolistic competition. In such a market structure increased demand and raised prices for a good will mean short-term profits for the firms that can produce the desired product. However in the long run, competition from other firms will result in lower prices for the good, subsequently meaning zero profit for the firms that were engaged in monopolistic competition.
If however, the competitive ratio of an industry is 80% an oligopoly occurs wherein the industry is dominated by a handful of key firms that are able to influence one another as well as the industry as a whole. A high competition ratio would indicate that there are strong barriers to entry in the industry and fierce competition among the strongest players (firms) in that industry. In these market conditions, the demand curve is kinked at a midpoint. Above the kink, the demand is elastic because of the set prices from the other firms. However, the demand is inelastic below the curve because of competition among the firms that ensures similar prices. An example of this is the beer industry where entry is difficult, key firms set the tone for all the others and price wars below the demand curve kink result in relatively inelastic demands.
Industries with high competition ratios are often a result of the top firms gradually gaining more market share until it becomes virtually impossible for others to join the industry. Low competition ratios are reflective of markets where it is simple to gain entry and the good produced is relatively easy to make and distribute because of the differentiation of products in the same industry.
In industries with high competition ratios, it is very difficult for small firms to thrive and profit and gaining the same status as the larger firms are almost impossible. However, it is possible for a small firm to stay afloat in this type of industry if they offer a specific good or benefit from brand loyalty. Being able to offer a very specific product within a larger industry can mean being able to remain profitable amidst much larger firms. An example of this is the presence of companies such as Bombardier and Embraer among large giants in the airline industry such as Boeing and Airbus. Because both Embraer and Bombardier offers exclusive commercial passenger jets for few people and the larger airplane manufacturers make large passenger craft, they are able to carve out their own market share in a large industry. Smaller firms can also thrive under policies and regulations which may protect them even with competition from larger firms.
- O'Sullivan, A., Perez, S., & Sheffrin, S. (2006). Economics: Principles, Applications, and Tools (5th Edition). Alexandria, VA: Prentice Hall.
- Ross, D., & Scherer, F. (1990). Industrial Market Structure and Economic Performance. Boston: Houghton Mifflin Company.
- Sutton, J. (2007). Sunk Costs and Market Structure: Price Competition, Advertising, and the Evolution of Concentration. London: The Mit Press.