Four Firm Concentration Ratio: Study with Video Lessons, Practice Problems & Examples

The 4-firm concentration ratio is a key measure of market power, calculated by dividing the total output of the four largest firms by the total industry output. For example, if the top four firms produce 970 units out of a total of 1161, the concentration ratio is 0.35 or 83.5%. This indicates that a significant portion of the market output is controlled by a few firms, highlighting the industry's concentration level and potential oligopoly structure. Understanding this ratio is crucial for analyzing competition and market dynamics.

Four Firm Concentration Ratio

So one method to evaluate the concentration in an industry, how much market power the firms have, is to use the 4 firm concentration ratio. Let's check that one out. So this one's pretty simple. The 4 firm concentration ratio, what we have to do is we're going to look at the output of the top 4 firms. The top 4 firms in the industry, the most output, right? When I say top 4, it's the 4 with the largest output, and we're going to divide that by the total industry output, okay? So we're going to take the 4 largest firms, add them together, and divide by the total for the industry. So let's go ahead and do an example here. It's the easiest way to learn this. So we've got a summary for the market of saxophone solos as shown below, what is the 4 firm concentration ratio? Right, so I'm just going all over the place with these products, it doesn't really matter what the product is, right? Let's go ahead and check this out. We've got a bunch of suppliers here, a bunch of famous, awesome saxophone players, and then of course, everyone's favorite, Brian, supplying 1 here at the bottom. Cool. So we've got 2 steps here. First, we need to find the total industry output, right? How many saxophone solos are being produced in this industry? Well, that's just a matter of adding up everybody's output, okay? So let's do that together and I'm just going to go down here and start adding, right? 350 plus 100 plus 50 plus 220 plus 80 plus 60, plus 300, plus 1. Okay. So we're getting a total output. Total output which is just the sum of all of those, I got 1161 as long as I didn't fat finger this and mess up my calculation. Our total output is 1161. So the other step is to find the 4 largest firms in this industry, right? So we got to find the 4 biggest numbers. Here we go. We've got John Coltrane producing 350, Cannonball, no. Bradford Marsalis down here is popping out 300. Looks like Cannonball Adderley's got the next one with 220 and then Charlie Parker with a 100 solos. Cool? So now we just add up these 4, right? The top 4 in the industry. So this is the output of the 4 largest is going to be equal to 350 plus 100 plus 220 plus 300. Okay. So let's add all those together and let's see what their output is. 350 plus 100 plus 220 plus 300. That gives me 970. 970 right there. So we're almost done. We're almost ready to tell us our answer here. So the 4 firm concentration ratio, 4 firm, and I'm just going to put CR. I don't know if that's a real acronym, I just got lazy. 4 firm concentration ratio, that's going to be the output of the 4 largest firms, 970 divided by the total industry output of 1161, and this gives us our 4 firm concentration ratio. 9701161, it is 0.835. I'll go to 3 decimals here. So 0.835, we could put that as a percentage, 83.5%. So what does that tell us? 83.5%, that means that the 4 largest firms in this industry account for 83.5% of the total output, right? So that does give us some information of how concentrated the industry is, right? There are a few large firms producing most of the output. Cool? Let's go on to the next video and do a practice where you guys can try the 4 firm concentration ratio. Cool, let's do that now.

A summary of the market for trumpet solos is shown below. What is the four-firm concentration ratio?

Alright, let's try this practice. A summary of the market for trumpet solos is shown below. What is the four-firm concentration ratio? So remember that the four-firm concentration ratio, I'll put CR out of laziness, is going to be the output of the four largest firms divided by the total industry output. Okay? Industry output. Alright, so there are two steps here. First, we have to find the total industry output and lucky for us, it was given in this problem, right? Total output, they added it up for us already. 17,231 trumpet solos being played. So we've got our total output, we've got our denominator. Now we need to find the four largest firms, right? Who is producing the most output? Well, let's go ahead and look for the four largest numbers. They all start with a 2, so I'm going to look for the next number here, 2850. Looks like Miles Davis has the highest output in this industry. Let's look for the next highest. It's gonna be Dizzy Gillespie here with 2750. Let me not cross out that number. 2750. Our next highest is going to be Lee Morgan with 2540 and then Louis Armstrong with 2400 trumpet solos. Cool, so we got to add those four numbers and that's going to be the output of the four largest, right. Output of the four largest. Well, that's going to equal 2400 plus 2850 plus 2750 plus 2540. Alright. So, what is that going to come out to? Pull out my handy dandy calculator. I don't feel like doing mental math right now. 2400 plus 2850 plus 2750 plus 2540. That gives us 10,540 as the output of the four largest. So the last step is just to calculate our ratio. Right? So that ratio, the concentration ratio here, that four-firm concentration ratio, you're going to take 10,540 divided by our total output which was given to us here, right, 17,231. We just got to do that division and we get 0.612 which I'll round off here, 61.2%, right? So, right behind my head, 61.2%. And that means that the top four firms in this industry are producing 61% of the total output. Cool? Alright. Let's go on to the next video.

Here’s what students ask on this topic:

What is the 4-firm concentration ratio and how is it calculated?

The 4-firm concentration ratio is a measure of market power that indicates the extent to which the top four firms dominate an industry. It is calculated by dividing the total output of the four largest firms by the total industry output. The formula is:

$\frac{(\mathrm{Output}\_1+\mathrm{Output}\_2+\mathrm{Output}\_3+\mathrm{Output}\_4)}{\mathrm{Total}\mathrm{Industry}\mathrm{Output}}$

For example, if the top four firms produce 970 units out of a total of 1161, the concentration ratio is:

$\frac{970}{1161}=\; 0.835$

This means that the top four firms control 83.5% of the market output.

Why is the 4-firm concentration ratio important in microeconomics?

The 4-firm concentration ratio is important in microeconomics because it helps to assess the level of competition within an industry. A high concentration ratio indicates that a few firms dominate the market, which can lead to oligopolistic behavior, reduced competition, and potentially higher prices for consumers. Conversely, a low concentration ratio suggests a more competitive market with many firms, which can lead to lower prices and more innovation. Understanding this ratio is crucial for analyzing market dynamics, regulatory policies, and the potential need for antitrust interventions.

How do you interpret a high 4-firm concentration ratio?

A high 4-firm concentration ratio indicates that the top four firms in an industry control a large portion of the total market output. For example, a ratio of 83.5% means that these firms produce 83.5% of the industry's total output. This suggests a high level of market concentration, which can lead to reduced competition, higher prices, and less innovation. It may also indicate the presence of an oligopoly, where a few firms have significant market power and can influence market conditions and prices.

What are the limitations of the 4-firm concentration ratio?

While the 4-firm concentration ratio is a useful measure of market concentration, it has several limitations. First, it only considers the top four firms, ignoring the market share of smaller firms, which can also impact competition. Second, it does not account for the distribution of market shares among the top four firms; for example, one firm could dominate while the others have much smaller shares. Third, it does not provide information on the competitive behavior of firms or potential barriers to entry. Therefore, it should be used in conjunction with other measures and analyses to get a comprehensive understanding of market dynamics.

Can the 4-firm concentration ratio be used to identify monopolies?

The 4-firm concentration ratio alone cannot be used to identify monopolies, but it can indicate the level of market concentration. A monopoly exists when a single firm controls the entire market. If the 4-firm concentration ratio is very high (close to 100%), it suggests that the market is highly concentrated and may be dominated by a few firms, potentially leading to oligopolistic or monopolistic behavior. However, additional analysis is needed to determine if one firm has monopoly power, including examining market shares, competitive behavior, and barriers to entry.