Question

An industry has five firms, each with a market share of 20 percent. There is no foreign competition, entry into the industry is difficult, and no firm is on the verge of bankruptcy. If two of the firms in the industry seek to merge, this action would most likely be opposed by the government because the Herfindahl index for the industry is _______ and the merger would increase the index by _______.

1) 2,500 and the merger would increase the index by 500
2) 2,000 and the merger would increase the index by 800
3) 2,500 and the merger would increase the index by 1200
4) 2,000 and the merger would increase the index by 500

Answer 1

The Herfindahl-Hirschman Index (HHI) for an industry with five firms each holding a 20 percent market share is 2000. If two firms merge, the new HHI would be 2800, an increase of 800. The government would likely oppose the merger due to the significant increase in market concentration. The correct answer is option 2.

Step-by-step explanation:

The Herfindahl-Hirschman Index (HHI) is a measure of market concentration used to assess the potential anticompetitive effects of mergers. To calculate the HHI, you sum the squares of the market shares of all firms in the industry. Currently, with five firms each holding a 20 percent market share, the HHI is calculated as follows:

HHI = 20^2 + 20^2 + 20^2 + 20^2 + 20^2 = 400 + 400 + 400 + 400 + 400 = 2000

If two of these firms were to merge, the new market shares would be 40 percent for the merged firm and 20 percent for each of the other three firms remaining:

HHI after merger = 40^2 + 20^2 + 20^2 + 20^2 = 1600 + 400 + 400 + 400 = 2800

The change in HHI due to the merger would be 2800 - 2000 = an increase of 800.

Therefore, the merger would likely be opposed by the government because it significantly increases the HHI, indicating a decrease in competition within the market. The correct option is 2) an original HHI of 2000, and the merger would increase the index by 800.