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Consider three market structures: monopolistic competition, perfect competition, and oligopoly
Consider three market structures: monopolistic competition, perfect competition, and oligopoly. The Herfindahl-Hirschman Indices (HHIs) computed for the three industries are 265, 3,620, and 1,050, in no particular order. Which statement is most likely to be true?
a. The HHI for the oligopolistic market is 265; the HHI for the perfectly competitive market market is 1,050.
b. The HHI for the monopolistically competitive market is 1,050.
c. The HHI for the oligopolistic market is 265; the HHI for the perfectly competitive market is 3,620.
d. There is not enough information to assign these HHIs to the market structures listed.
Expert Solution
The answer is b.
The Herfindahl-Hirschman Indices are computed as the sum of squared market shares of firms in an industry, and range from 0 to 1 (or 0 points to 10,000 points if instead expressed as basis points). The higher the index, the less competitive the market is.
From basic economic theory we know that the firms in a perfectly competitive market have no market power, and this type of market should have the lowest Herfindahl-Hirschman Index. Also, oligopoly is less competitive than a monopolistic competitive market, and should have a higher Herfindahl-Hirschman Index. Based on these rankings, the appropriate scores should be:
- perfect competition: 265
- monopolistic competition: 1050
- oligopoly: 3620
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