Question

Market shares in the U.S. cigarette industry are as follows.

Cigarette Company	Market Share (Percent)
Altria	50
Reynolds	35
Vector	5
Republic	4
three smallest companies	each 2
Total	100

1. 1. Define the four-firm concentration ratio of an industry. Compute the four-firm concentration ratio for the cigarette industry. Show your computation.

2. Define the Herfindahl-Hirschman index (HHI). Compute the HHI for the cigarette industry. Show your computation.

3. The cigarette industry is often described as a “duopoly.” Explain how this description makes sense, even though there are more than two firms in the industry.

4. According to the U.S, government, what is the classification of the cigarette industry in terms of “concentration”? Explain your answer.

5. (a) Suppose that Altria and Reynolds explore a merger of the two companies. Is this merger likely to be approved by the U.S. government? Explain your answer using the HHI concept.

    (b) Instead of Altria and Reynolds merging, suppose that the three smallest companies decide to merge. Is this merger likely to be approved by the U.S. government? Explain your answer using the HHI concept.

Answer 1

1) Concentration ratio is used to measure the competitiveness of any industry or sector. In this method, market share in percentage terms of the largest required number of firms is added. If the calculation is for 4 firm concentration then the largest 4 firms market share is added while the number will change 8 firms if the 8 firm concentration needs to be calculated.

4 firm concentration ratio = 50% + 35% + 5% + 4%
= 94%

2) Herfindahl-Hirschman index or commonly known as HHI is another method to measure the competitiveness of the industry. HHI can be calculated by taking a square of the market share of each firm and then taking a sum of it. HHI below 1500-1600 is considered a competitive market and if the HHI is above 2500 then it is considered as a concentrated market.

HHI =( 50^2 )+( 35^2 )+( 5^2 )+( 4^2 )+( 2^2 )+( 2^2 )+( 2^2 )
HHI = 3778

3) There are 7 companies in this cigarette industry but three firms are so small that their market share is only 2% each. They can not influence the market and for that matter next large two firms are also very small. Lower 5 firms have a market share of only 15% and the largest two firms command a total market share of 85%. This is nothing but duopoly which proves that the cigarette industry tends to be a duopoly market.

4) According to the U.S. Department of Justice, the cigarette industry is considered as highly concentrated. The department considers an industry highly concentrated if its HHI is above 1800. Although, the department has not issued HHI numbers for the cigarette industry in the US but the largest 4 firms have 89% of market share which indicates the scenario.

5) The U.S. Department of Justice considers rise by 200 or more points HHI because of a merger as not suitable for the overall industry. If the merger between Altria and Reynolds is allowed then earlier HHI 3378 will rise to 7278.
This is a potential case of almost monopoly and the new firm can use its market power for its profit.
This merger will be rejected.

6) The U.S. Department of Justice considers rise by 200 or more points HHI because of a merger as not suitable for the overall industry. If the smaller 3 firms decide to merge then HHI will change from the earlier value of 3778 to 3802.
This is not a significant change which can adversely affect the market and so that should go through.