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0. Basic Principles of Economics1h 5m
1. Reading and Understanding Graphs59m
2. Introductory Economic Models1h 10m
3. The Market Forces of Supply and Demand2h 26m
4. Elasticity2h 26m
5. Consumer and Producer Surplus; Price Ceilings and Floors3h 45m
6. Introduction to Taxes and Subsidies1h 46m
7. Externalities1h 12m
8. The Types of Goods1h 13m
9. International Trade1h 16m
10. The Costs of Production2h 35m
11. Perfect Competition2h 23m
12. Monopoly2h 13m
13. Monopolistic Competition1h 9m
14. Oligopoly1h 26m
15. Markets for the Factors of Production1h 26m
16. Income Inequality and Poverty35m
17. Asymmetric Information, Voting, and Public Choice39m
18. Consumer Choice and Behavioral Economics1h 16m

12. Monopoly

Mergers and the Herfindahl-Hirschman Index (HHI)

12. Monopoly

Mergers and the Herfindahl-Hirschman Index (HHI): Videos & Practice Problems

Video Lessons Practice Worksheet

Topic summary

Mergers occur when two firms combine into one, categorized as horizontal or vertical. Horizontal mergers involve firms in the same industry, raising competition concerns, while vertical mergers occur between firms at different production stages. The Herfindahl-Hirschman Index (HHI) measures market concentration: an HHI below 1500 indicates low concentration, 1500-2500 is moderate, and above 2500 signals high concentration, prompting government scrutiny. The HHI is calculated by squaring each firm's market share and summing the results, reflecting market power and potential economic impacts.

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Mergers and the HHI

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Mergers and the HHI Video Summary

Mergers occur when two separate firms combine to form a single entity, and they can significantly impact market dynamics. There are two primary types of mergers: horizontal and vertical. Horizontal mergers involve firms within the same industry, which can raise concerns about reduced competition. A notable example is the attempted merger between AT&T and T-Mobile, which was ultimately blocked by the government due to fears it would diminish competition and increase market power.

In contrast, vertical mergers occur between firms at different stages of production. A classic example is eBay's acquisition of PayPal, which allowed eBay to streamline transactions by eliminating the need for a third-party payment processor. The government tends to scrutinize horizontal mergers more closely than vertical ones, as the former poses a greater risk to competitive market structures.

To assess the potential impact of a merger on market competition, the government utilizes the Herfindahl-Hirschman Index (HHI). This index measures market concentration, which reflects the degree of market power firms hold and their ability to influence prices. The HHI is calculated by squaring the market share of each firm in the industry and summing these values. For instance, if a firm has a 20% market share, it contributes $20^2 = 400$ to the HHI.

The interpretation of HHI values is crucial for understanding market concentration. An HHI below 1500 indicates a low concentration level, suggesting that mergers are generally permissible without significant concerns about competition. An HHI between 1500 and 2500 signifies moderate concentration, prompting the government to exercise caution regarding potential mergers. An HHI above 2500 indicates a highly concentrated market, leading to increased scrutiny and potential restrictions on mergers to protect competitive practices.

Problem

Calculate HHI in the following industries:
One firm with 100% market share
Two firms with 50% market share
Four firms with market shares of 30%, 30%, 20%, and 20%
Ten firms with 10% market share

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Problem

The HHI for this industry is:

2,704

4,439

100,000

3,688

Problem

The monkey smoking a cigar industry is:

Not concentrated

Moderately concentrated

Highly concentrated

Not enough information

Problem

The HHI for this industry is:

100

1,000

1,600

3,000

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Here’s what students ask on this topic:

What is the Herfindahl-Hirschman Index (HHI) and how is it calculated?

The Herfindahl-Hirschman Index (HHI) is a measure of market concentration used to determine the level of competition within an industry. It is calculated by squaring the market share of each firm in the industry and then summing the results. The formula is:

$HHI = \sum_{i = 1}^{n} s^{2}$

where $s$ is the market share of firm $i$ and $n$ is the total number of firms. An HHI below 1500 indicates low concentration, 1500-2500 indicates moderate concentration, and above 2500 indicates high concentration.

What are the differences between horizontal and vertical mergers?

Horizontal mergers occur between firms in the same industry, often raising concerns about reduced competition and increased market power. An example is the attempted merger between AT&T and T-Mobile. Vertical mergers, on the other hand, involve firms at different stages of production. These mergers are generally less concerning to regulators. An example is eBay's acquisition of PayPal, which integrated payment processing into its auction platform. Horizontal mergers are scrutinized more heavily due to their potential to significantly alter market dynamics.

Why does the government use the HHI to evaluate mergers?

The government uses the Herfindahl-Hirschman Index (HHI) to evaluate mergers because it provides a quantitative measure of market concentration. By assessing the HHI, regulators can determine whether a merger will significantly reduce competition and increase market power. An HHI below 1500 suggests low concentration and likely approval, 1500-2500 indicates moderate concentration requiring caution, and above 2500 signals high concentration, warranting stringent scrutiny. This helps ensure that mergers do not harm consumer welfare by creating monopolistic or oligopolistic market conditions.

What is considered a highly concentrated market according to the HHI?

A highly concentrated market according to the Herfindahl-Hirschman Index (HHI) is one with an HHI above 2500. In such markets, a few firms hold significant market power, which can reduce competition and potentially lead to higher prices and lower quality for consumers. When the HHI exceeds 2500, the government is likely to scrutinize mergers more closely to prevent further concentration and protect consumer interests.

How do horizontal mergers impact market competition?

Horizontal mergers impact market competition by potentially reducing the number of competitors within the same industry. This can lead to increased market power for the merged entity, allowing it to influence prices, output, and innovation. Reduced competition can result in higher prices and fewer choices for consumers. Consequently, horizontal mergers are subject to rigorous scrutiny by regulators to ensure they do not harm consumer welfare or create monopolistic conditions.