a. Analysts and market regulators are hugely concerned with the degree of market competition. This is mainly because; the degree of competition is responsible for both the pricing power and the profitability of a firm.
b. When analyzing a merger, one should always consider the impact of the competition law or the anti-trust law.
c. The econometric approaches may be used for measuring the market competition or the market power, as follows:
i. Use regression analysis to estimate the elasticity of demand and supply.
ii. A highly inelastic demand curve indicates a lot of pricing power in the hands of the firms in the industry in question.
iii. The econometric approach may be theoretically very appealing, but in reality, the data required for this analysis is not very easily available.
d. The simpler approaches include the N-firm concentration ratio and Herfindahl-Hirshman Index (HH Index).
1.1. N-Firm Concentration Ratio
a. This ratio is calculated by taking the sum of N largest firms in the industry.
b. The biggest advantage of using this ratio is that it is simple to use and understand.
c. Some of the disadvantages of using this ratio are:
i. This ratio remains unaffected by the merges among the top incumbents.
ii. This ratio does not quantify the market power.
iii. This ratio does not consider the barriers to entry.
iv. This ratio does not consider the elasticity of demand.
1.2. HH Index
a. This ratio is calculated by taking the sum of squared market shares of N largest firms in the market.
b. This ratio ranges between 0 and 1.
c. This ratio is also simple to calculate and commonly used by the regulators.
d. The biggest disadvantage of this ratio is that it does not consider the barriers to entry and elasticity of demand.