Herfindahl-Hirschman index. Formula. Application


The Herfindahl-Hirschman index is one of the main indicators by which one can distinguish between markets of pure monopoly, oligopoly, monopolist and perfect competition. It shows how many companies are represented in a particular market segment, what is the share of their products.

Formula for determining the index

The formula of the Herfindahl-Hirschman index is as follows: HHI = S 1 2 + S 2 2 + … + S n 2,

where S 1 2 and S 2 2 are the squared percentage of the company's goods and services in a particular industry. This part is defined as the ratio of the manufacturer’s sales in the market to the entire volume of goods or services in the industry. The value obtained should be in the range between 1 and 10, 000. A value of 10, 000 means complete monopolization of the economic sector by one company.

Herfindahl-Hirschman index shows the level of concentration in the industry. It should be noted that this parameter is closely related to the coefficient of monopoly power of Lerner. In addition, it should be emphasized that HHI is an effective indicator of changes in the market share of a company. He is also able to indirectly indicate the amount of economic profit derived from the use of monopoly power.

The above formula makes it possible to separate the influence on HHI of the number of companies in the industry and the division of the market between them. Provided that all manufacturers control the same parts of the industry, the scatter will be zero. Then the value of HHI is inversely proportional to the number of companies represented in the market. At the same time, with a fixed number of manufacturers, HHI increases with the growth of the difference between the parts of firms in the industry.


Use index

As already mentioned, the Herfindahl-Hirschman index indicates the level of monopolization of a certain sector of the economy. It is widely used by the US Department of Justice to analyze emerging merger transactions. In addition, since 1982, the HHI is the basic parameter that is used in America for the implementation of state antitrust policy. The fundamental advantage of the index is the ability to clearly demonstrate the redistribution of parts of the industry between different companies.


Herfindahl-Hirschman Index as a way to combat monopolies

When analyzing the index, the level of concentration in the industry is estimated. In practice, this means that the closer the market to a monopoly, the lower the level of competition and the higher the concentration. Let's give an example. If the industry is entirely occupied by one company, then HHI will be equal to 10, 000, since this company has one hundred percent market share. In this case, obviously, we are talking about a monopoly.

On the other hand, if a thousand companies are represented in a particular industry, the market share of each of which tends to zero, then the index will also be close to zero. This, in turn, indicates the existence of practically perfect competition in the industry. In accordance with the methodology used in the US Department of Justice, a branch with a Herfindahl-Hirschman index less than 1000 is considered competitive. If the value of HHI is in the range between 1000 and 1800, then the market is moderately focused. An indicator exceeding 1800 indicates a high concentration in the economic sector.


HHI and Lerner coefficient

HHI and the Lerner coefficient are interrelated, since the latter is the ratio of the Herfindahl-Hirschman index and the elasticity of demand. However, this formula has one drawback. In order to accurately calculate HHI, it is necessary to know the parts in the market of all manufacturers of a particular product or service. And this, in turn, is not always possible because of their large number.

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