The Herfindahl index solves which problem with the N-Firm ratio?

Question

BlackTom AI · Accepted Answer

To understand the question, we need to connect the Herfindahl index with the N-Firm ratio and the specific problem it mitigates.
Option A: 'Inability to measure concentration if market shares are split evenly' This would imply measuring concentration is impossible when shares are equal, which is not accurate for the HHI, since equal shares still yield a calculable index, albeit a lower one; the problem here isn’t about noon-equality but about sensitivity to firm size distribution.
Option B: 'High variability when firm sizes are small' The Herfindahl index is not primarily described as having high variability merely because individual firm sizes are small; instead, it aggregates the squared shares, so the issue isn’t about small firms per se but how distribution shapes the sum of squares.
Option C: 'Invariance with changes in the size of the largest firms' This choice points to a property that the N-Firm ratio attempts to address by stabilizing comparisons when the largest firm sizes change, ensuring comparisons aren’t distorted solely by one dominant firm; the Herfindahl approach (sum of squares) aligns with this goal by reflecting concentration without being overly sensitive to a single large firm’s size changes in isolation, thus mitigating that particular concern.
Option D: 'Inability to measure concentration across borders' The HHI is a domestic concentration measure; cross-border issues involve other considerations like multinational firm footprints and integration, which isn’t the core problem the HHI fixes within the N-Firm framework.
Option E: 'Inaccuracy when dealing with more than 4 firms' The HHI can handle any number of firms, and the issue with the traditional four-firm concentration ratio is precisely that it ignores the rest of the market; the HHI overcomes that by including all firms, so this option misstates the limitation it addresses.
In summary, the most accurate framing is that the N-Firm ratio seeks robustness against the changing sizes of the largest firms, and the Herfindahl index provides a comprehensive measure that remains informative under such changes by incorporating the full distribution of market shares rather than a fixed cap on the number of firms. This aligns with why the option describing invariance with changes in the size of the largest firms is identified as the correct one.

The Herfindahl index solves which problem with the N-Firm ratio?

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