Explanation
The concentration ratio measures the combined market share of the largest firms in an industry (typically the top 4 or 8 firms). While it provides an indication of market concentration, it has several limitations:
Why Option B is correct:
- Indirect measure: The concentration ratio doesn't directly measure market power - it only measures market share concentration. Market power refers to a firm's ability to influence prices, output, and competition, which depends on many factors beyond just market share.
- Missing information: It doesn't account for:
- Barriers to entry
- Product differentiation
- Elasticity of demand
- Potential competition
- Geographic market boundaries
- Import competition
Why other options are incorrect:
- Option A: Concentration ratios are actually relatively easy to compute using market share data, making this statement false.
- Option C: While mergers do affect concentration ratios, this is actually a feature, not a disadvantage. The ratio should reflect changes in market structure, including mergers.
Additional disadvantages of concentration ratios:
- Arbitrary cutoff: The choice of top 4 vs top 8 firms is arbitrary
- Ignores distribution: A 4-firm ratio of 80% could mean 20% each or 50%, 15%, 10%, 5%
- No information about smaller firms: Doesn't show the competitive fringe
- Geographic limitations: Assumes national markets when some are local/regional
Better alternatives:
- Herfindahl-Hirschman Index (HHI)
- Lerner Index
- Price-cost margins
- Entry barrier analysis
Therefore, the primary disadvantage is that concentration ratios provide an indirect, incomplete measure of market power rather than directly quantifying it.
