Explanation

The correct answer is C: "is less affected by mergers among the top market incumbents."

Key Differences Between Concentration Ratio and HHI:

1. Concentration Ratio (CRn):

   • Measures the combined market share of the top 'n' firms in an industry
   • Typically uses CR4 (top 4 firms) or CR8 (top 8 firms)
   • Less sensitive to mergers among top firms because it only considers the combined market share of the top firms
   • Does not account for the distribution of market shares among the top firms

2. Herfindahl-Hirschman Index (HHI):

   • Calculated as the sum of squares of market shares of all firms in the industry
   • Formula: HHI = Σ(s_i²) where s_i is the market share of firm i (expressed as a percentage)
   • More sensitive to mergers among top firms because squaring gives more weight to larger firms
   • Accounts for the distribution of market shares across all firms

Why Option C is Correct:

• When two large firms merge, the HHI increases significantly because the squared market share of the merged entity is much larger than the sum of their individual squared market shares
• The concentration ratio would show a smaller change because it simply adds the market shares of the merging firms

Why Other Options are Incorrect:

• Option A: Neither HHI nor concentration ratio directly considers elasticity of demand. Both are structural measures of market concentration.
• Option B: Neither measure accounts for the possibility of new entrants. Both are static measures of current market structure.

Example:

Suppose an industry has 4 firms with market shares: 40%, 30%, 20%, 10%

• CR4 = 100% (40+30+20+10)
• HHI = 40² + 30² + 20² + 10² = 1600 + 900 + 400 + 100 = 3000

If the top two firms merge (40% + 30% = 70%):

• CR4 = 70% + 20% + 10% = 100% (no change in CR4)
• HHI = 70² + 20² + 10² = 4900 + 400 + 100 = 5400 (significant increase from 3000)

This demonstrates that HHI is more affected by mergers among top firms than the concentration ratio.