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Published on September 5th, 2022 | by Bibhuranjan

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A Short Guide to Market Concentration

The measurement of market concentration between several small firms plays a key role in calculating a company’s competitiveness in the market. That’s why it’s important to know exactly what market concentration is and its effects on the economy.

What is market concentration?

Market concentration is the distribution of market shares among a small number of firms. The more highly a market is concentrated the less competitive it is. A market with low

concentration isn’t dominated by any large firm and is considered competitive.

Markets with low concentration are observed to be fragmented. This means there is no one company that can deploy enough influence to move the industry in one distinct direction.

How to calculate a market’s location quotient

A location quotient is a ratio used to determine the concentration or dominance of an industry in a region in comparison to a larger reference or geographic unit. It’s determined as an industry share of a regional total for some economic statistics.

Calculate the location quotient by first, finding the proportion of the entire economy that a certain industry employs. Divide the average employment for that industry by the all-industry, all-ownership total of local employment. The second step in calculating a location quotient is dividing national industry by all-industry, all-ownership total for the nation. Finally, divide the local ratio by the national ratio.

Occupations with a high location quotient are important, as they are employed by high-LQ industries and, as result, provide a workforce-directed perspective of the region’s economic base.

The four types of market structures

The main types of market structure include the following:

Perfect Competition

Perfect competition refers to a market structure, where a great number of small firms compete against each other. No one particular firm has any significant market power. As result, the industry as an entity produces an optimal level of output, because none of the firms can influence market prices.

The perfect competition builds with several factors: all firms maximize profits, free entry/exit to the market, all firms sell identically, and no consumer preferences. The best example of perfect competition can be seen in the stock market. According to Investopedia, perfect competition is an ideal type of market structure.

Monopolistic Competition

Monopolistic competition describes a market structure, where a big number of small firms compete against each other. However, unlike perfect competition, the firms sell similar but minorly different products. Which gives them a certain degree of market power and allows them to charge higher prices within a specific range.

Monopolistic competition construction: all firms maximize profit, free entry/exit to the market, firms sell differentiated products, and consumers prefer one product over the other. An example is a market for cereals. Most cereals taste differently, but in the end, all are breakfast food.

Oligopoly

An oligopoly refers to a market structure that is controlled by only a small number of firms. It’s a state of limited competition where firms either compete against each other or collaborate. Together their power can be used to drive up prices and earn more profit.

The oligopoly market structures of all firms maximize profit, oligopolies can set prices, barriers to enter/exit the market, products may be homogenous or differentiated, and only a few firms dominate the market.

Monopoly

A monopoly describes a market structure where a single firm controls the whole market. The highest market power belongs to the firm, as consumers don’t have alternatives. Corispondegly, monopolies reduce output to increase prices and earn a bigger profit.

A few factors to define the monopolist market are: the monopolist maximizes profit, they can set a price, high barriers to enter/exit, and only one firm dominates the entire market.

The key effects of market concentration on the economy

According to Forbes, it has seen by economists that the market is getting taken over by a few large companies. Leading to consequences – lackluster output growth, reduced innovation and investment, excess returns on capital, and growing economic inequality.

High market concentration negatively affects the economy, since the higher it gets the more it deters healthy competition, leading to low investment by companies that don’t want to keep up. It’s nearly impossible for small businesses to compete or for new businesses to enter the market.

Main factors that increase market concentration

There are certain market concentration factors, which are important to keep in mind. These include the following:

  • An increase in concentration is led by an innovation increase. Firms earn the power to control prices and the market.
  • When firms earn power over important resources, squeezing out small firms.
  • Technology advances over time, making production more effective.
  • Small groups exert power over the market by cooperating in restricting output or setting prices.
  • Differentiated products result in a collision to set prices.
  • Market concentration is increased when two firms sell equally-desirable products.

Cover Image by Freepik

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Editorial Officer, technofaq.org I'm an avid tech enthusiast at heart. I like to mug up on new and exciting developments on science and tech and have a deep love for PC gaming. Other hobbies include writing blog posts, music and DIY projects.



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