In a widely anticipated move, Reynolds American, producer of best-selling brand
ID: 1161656 • Letter: I
Question
In a widely anticipated move, Reynolds American, producer of best-selling brand Camel, announced yesterday that it has agreed to buy Lorillard, maker of Newport, the number 1 menthol cigarette. The $25 billion deal will combine the number 2 and number 3 cigarette manufacturers. The new company, retaining the Reynolds American name, will have 35 percent of the U.S. market, running second to Altria’s 47 percent share. As part of the deal, Imperial Tobacco will purchase several of Lorillard’s brands, including Blu, its popular e-cigarette, and end up with 10 percent of the market. Liggett Vector will keep 4 percent of the market. Prior to merging, Reynolds had 25 percent of the market and Lorillard had 12 percent, with Imperial at 8 percent.
Reynolds expects to cut annual costs by $800 million through eliminating overlap in sales, production, and overhead costs. Consumers worry that reduced competition will raise cigarette prices and further limit choices. The deal must win antitrust approval before it is finalized.
Source: News reports, July 15-18, 2014.
What were the values of:
Instructions: Enter your responses rounded to nearest whole number.
(a) The concentration ratio in the cigarette industry
(i) Prior to the merger?
(ii) After the merger?
(b) The maximum value of the Herfindahl-Hirshman Index?
(i) Prior to the merger?
(ii) After the merger?
(c) Which measure best reflects the increased market power?
Explanation / Answer
Answer:
The Herfindahl index (HI) is calculated as the sum of the squares of the market shares of each firm in an industry.
0 .111 .1000 very low concentrated 1800 .1800 Moderately concentrated 1800 Highly concentrated
The firm concentration ratio (FCI) is calculated as the percentage of market share in an industry held by the largest firms within that industry.
0 50 Low concentrated industry 50 <FCI 80 Moderatly concentrated industry 80 .100 Highly concentrated industry
The Herfindahl index of one of the industry is 1,200 and an industry of four firms has concentration ratio of 55%.
Therefore, on the basis of above information, it can be said that both the industries are moderately concentrated.
(a)
Concentration ratio calculation:
O
Before merger, the concentration ratio of the four firms is equal to the sum of 47% Altria's,
25% of Reynolds's,
12% of Lorillard's and 4% of Liggett's.
Therefore, concentration ratio equals 96% (45%+25%+12+4).
After merger, the concentration ratio of the two firms is equal to the sum of 47% Altria's, 35% of Reynolds's, 10% of Lorillard's and 4% of Liggett's.
Hence, concentration ratio equals 96% (45%* 35%+10%+4%).
(h)
Calculating Herrmdahl Hirschman index (11111):
Before merging:
EBB = (0.47)'' -F (0.25)' -F (0.12)' -F (0.8)' (0.4)2
= 0.2209 -F 0.0625+ 0.0144 -F 0.64+ 0.16
= 1.0978
(b)
Calculating Herfindahl Hirschman index (HHI):
Before merging: HHI = (0.47)2 +(0.25)2 +(0.12)2 +00.02 +0.02
= 0.2209+ 0.0625+ 0.0144 + 0.64+ 0.16
= 1.0978
After Merging:
HHI = (0.47)2 + (0.35)2 + (0.10)2 +(0.4)2
= 0.2209+0.1225+0.01+0.16
=0.5134
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