Imagine that you are employed by the U.S. Department of Justice and you are on the team that must determine the type of market structure for the tattoo industry. Table 1 shows the total revenue of the 50 firms in the tattoo industry.

First, calculate the market share by dividing the total revenue of the firm (numerator) by the total industry revenue (denominator) for each firm. See the example for Tattoo Time.

1. The four-firm concentration ratio is 46.6. Calculate the HHI using the HHI formula. Based on Table 2, what is the market structure of the tattoo industry? (Perfect, monopoly, monopolistic, oligopoly)
2. What would the market structure of the tattoo industry be if each firm operated in a different city and the cities were spread across the nation (Hint: keep in mind there are only 50 firms in the industry)
3. What additional information would you need about the tattoo industry to be sure that it is an example of monopolistic competition?
4. Suppose that a new tattoo technology makes it easier for anyone to enter the tattoo market. How might the market structure change?
5. Based on your answer, why is it important to calculate the know the HHI as it relates to competition?

EXAMPLE

Table 1

Firm Total Revenue Market share

(dollars) (total revenue/industry)

Tattoo Time 450 17.1

My Tat 325

Love Lines 250

Native Birds 200

Next 16 firms (each) 50

Next 30 firms (each) 20

Industry 2,625

How to calculate The Herfindahl-Hirschman Index (HHI)

The Herfindahl-Hirschman Index - also called the HHI - is the square of the percentage market share of each firm summed over the 50 largest firms (or summed over all the firms if there are fewer than 50 ) in a market. For example if there are four firms in a market and the market shares of the firms are 50 percent, 25 percent, 15 percent, and 10 percent, the Herfindahl-Hirschman Index is

HHI = 502 + 252 + 152 + 102 = 3,450.

In perfect competition, the HHI is small. For example, if each of the 50 largest firms in an industry has a market share of 0.1 percent, the HHI is 0.12 X 50 =0.5. In a monopoly, the HHI is 10,000 - the firm has 100 percent of the market: 1002 = 10,000.

The HHI became a popular measure of the degree of competition during the 1980s, when the Justice Department used it to classify markets. A market in which the HHI is less than 1,000 is regarded as being competitive and an example of monopolistic competition. But a market in which the HHI exceeds 1,800 is regarded as competitive. The Justice Department scrutinizes any merger of firms in a market in which the HHI exceeds 1,000 ad is likely to challenge a merger if the HHI exceeds 1,800.