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CFA Level I · CFA Level I Exam · The Firm and Market Structures

Regulators observe that the four-firm concentration ratio in an industry has fallen from 85% to 60% over a decade, but the HHI has remained almost unchanged. The most likely explanation is that:

The most likely explanation is that the largest firm kept its dominant share while the next three firms lost share. HHI squares market shares, so it is dominated by the leader and barely moves, while the four-firm ratio falls as the other top firms shrink.

  1. Athe market share of the largest firm has remained dominant while the next three firms lost shareCorrect
  2. Bthe market is becoming perfectly competitive because the ratio has fallen
  3. Cthe concentration ratio is sensitive to mergers among small firms whereas the HHI is not

Explanation

HHI squares shares, so it is heavily driven by the largest firm. If the leader's share stayed large while firms two to four lost share, the ratio falls while HHI changes little. A fall in the ratio alone does not indicate perfect competition, and the ratio ignores mergers among small firms outside the top four.

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