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Herfindahl index


The Herfindahl index (also known as Herfindahl–Hirschman Index, or HHI) is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them. Named after economists Orris C. Herfindahl and Albert O. Hirschman, it is an economic concept widely applied in competition law, antitrust and also technology management. It is defined as the sum of the squares of the market shares of the firms within the industry (sometimes limited to the 50 largest firms), where the market shares are expressed as fractions. The result is proportional to the average market share, weighted by market share. As such, it can range from 0 to 1.0, moving from a huge number of very small firms to a single monopolistic producer. Increases in the Herfindahl index generally indicate a decrease in competition and an increase of market power, whereas decreases indicate the opposite. Alternatively, if whole percentages are used, the index ranges from 0 to 10,000 "points". For example, an index of .25 is the same as 2,500 points.

The major benefit of the Herfindahl index in relationship to such measures as the concentration ratio is that it gives more weight to larger firms.

The measure is essentially equivalent to the Simpson diversity index, which is a diversity index used in ecology, and to the inverse participation ratio (IPR) in physics.

For instance, we consider two cases in which the six largest firms produce 90% of the goods in a market. In either case, we will assume that the remaining 10% of output is divided among 10 equally sized producers.

The six-firm concentration ratio would equal 90% for both case 1 and case 2. But the first case would promote significant competition, where the second case approaches monopoly. The Herfindahl index for these two situations makes the lack of competition in the second case strikingly clear:


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