In economics, concentration ratios measure the output of an industry by analyzing the total output of the largest firms within that industry. Concentration ratios focus on the market share of the largest firms within an industry to determine the monopolistic competition and market dominance within an industry. While this method provides a framework for overall market dominance, measuring monopoly and oligopoly power within a market using a concentration ratio can lead to inaccurate data within the results.
Concentration ratios are used predominantly to study market dominance and a ratio can be utilized with any number of firms. However, the standard concentration ratios used in market evaluation are the four-firm and eight-firm ratios. The four-firm ratio measures the market share of the four largest firms in a given industry while the eight-firm ratio expands to the eight largest firms in a given industry. The total percentage these firms hold of market share directly relates to the control these firms have over the marketplace.
The four basic market structures are perfect competition, monopolistic competition, oligopoly and monopoly. Perfect competition refers to a market structure where competition is extreme and no firm has a dominant market share. Perfect competition is deemed unreachable in the market. Monopolistic competition refers to the market structure made up of a large number of small firms that provide a similar but not identical product or service. Information regarding these products and services such as price and technology are widely known between firms. Oligopoly and monopoly, in contrast, are market structures that refer to a small number of firms (oligopoly) or one firm (monopoly) and information such as price and technology is not readily available or shared.
Concentration ratios are categorized as high, medium and low. High concentration levels run from 80 to 100 percent of total market share, medium run from 50 to 80 percent and low covers the bottom 50 percent of the market share. In a one-firm concentration ratio, a zero market share would represent perfect competition while market share of 100 percent would represent a monopoly. Using a standard four-firm ratio and getting a percentage of over 90 percent would indicate that the industry is an oligopoly, dominated by the four largest firms. As the percentage decreases, the level of monopolistic competition increases as the four largest firms have less and less control over the total market share.
One of the shortcomings of applying concentration ratios to monopoly and oligopoly power over a market is that it can provide inaccurate results due to a scope of the market. Markets can be local, national and even global, which can shift the range of the results. A few firms might exert dominance in a regional market but in the national or global market the results might be very different.
Within an industry one firm might hold dominance over other firms within the market. That doesn't necessarily mean that competition is lacking, merely that it is less effective in challenging the more dominant firm financially or in quality of products or services.
The widening of the global market brings more competition into the equation. High domestic concentration ratios do not account for burgeoning global competition. Moreover, distribution of power among the leading firms in an industry is difficult to measure accurately, leading to shortsighted results.