When two wineries merge into one, what is the most likely effect on the Herfindahl-Hirschman Index (HHI) for the wine industry?

• A. The HHI increases, indicating greater market concentration.
• B. The HHI fluctuates randomly and does not reflect mergers.
• C. The HHI decreases, indicating less market concentration.
• D. The HHI remains unchanged, as mergers do not affect market concentration.

Answer: (A)

Verified step by step guidance

1. Understand that the Herfindahl-Hirschman Index (HHI) is a measure of market concentration calculated by summing the squares of the market shares (expressed as percentages) of all firms in the industry: \(HHI = \sum_{i=1}^N (S_i)^2\), where \(S_i\) is the market share of firm \(i\).
2. Recognize that when two wineries merge, their combined market share becomes the sum of their individual market shares, effectively reducing the number of firms in the market by one.
3. Calculate the new HHI by removing the squares of the two separate firms' market shares and adding the square of their combined market share: \(HHI_{new} = HHI_{old} - (S_a)^2 - (S_b)^2 + (S_a + S_b)^2\), where \(S_a\) and \(S_b\) are the market shares of the merging wineries.
4. Note that because \((S_a + S_b)^2 > (S_a)^2 + (S_b)^2\) for positive \(S_a\) and \(S_b\), the new HHI will be higher than the old HHI, indicating increased market concentration.
5. Conclude that the merger leads to an increase in the HHI, reflecting greater market concentration in the wine industry.