11) Oligopoly Flashcards
define n-firm concentration ratio
a measure of a market share of the largest n firms in an industry
define oligopoly
a market with a few dominant sellers, in which each firm must take account of the behaviour and likely behaviour of rival firms in the industry
define non-price competition
a strategy whereby firms compete by advertising to encourage brand loyalty, or by quality or design, rather than on price
define cartel
an agreement between firms on price and/or output with the intention of maximising their joint profits
define tacit collusion
a situation occurring when firms refrain from competing on price, but without communication or formal agreement between them
define strategic alliance
a long-term cooperative arrangement between firms, such as sharing networks or bulk buying
define price leadership
a dominant producer sets a price and competitors follow
define barometric price leadership
a firm tries out a price increase to see if competitors follow, and cuts prices if they don’t
how is market share usually calculated?
Market share is usually calculated as the % of sales a firm has out of total sales
how can market share also be calculated?
• % of total sales revenue
• % of profits
• % of employees
If the number of firms in a market falls, the market becomes more…
concentrated
what does the n-firm concentration ratio tell us?
the % of the market share captured by the top n firms
characteristics: how many firms?
a few large firms meaning the market is dominated by a few sellers gaining from economies of scale
characteristics: are there barriers to entry
High barriers to entry
what do high barriers to entry mean?
new entrants can’t easily compete away SP, and smaller firms can exist but without significant impact on prices and output
characteristics: what sort of competition is there?
Non-price competition - firms avoid competing on price, but engage in product differentiation in different ways
price makers or takers?
price makers so have the power to set prices
there is inderoendent decision making, what does this mean?
each takes strategic decisions on price and output based on likely rival actions and reactions
what can oligopolies be similar to?
Oligopolies may behave like monopolies at times, and at others like a much more competitive market
If a price war breaks out firms may choose price and output like monopolistic competition
how do firms engage in non-price competition?
• Firms engage in non-price competition by competing with:
• Innovation
• Customer service
• Free upgrades
• Exclusivity
• Loyalty schemes
• Branding
° (Non-price) sales promotions
• Convenient location
• Breadth of product range
why do firms engage in non-price competition?
• Firms do this to keep revenues and profits high, as firms do not want to be forced onto the inelastic part of the demand curve
• Oligopolies can do this because few firms make tacit collusion possible
because there are few competitors what do firms try to do?
anticipate the actions of their rivals
what does anticipating the actions of rivals mean?
This means that firms may compete or cooperate depending on the situation
what can oligopolies assume if one firm raises prices?
Oligopolies can assume that if one firm raises prices, because other firms will not, the firm will lose the customers that switch to other firms’ products - lowering profits; demand is price elastic when prices rise
demand is price elastic when prices…
rise
what is assumed when one firm lowers prices?
But if one firm lowers prices, other firms follow to avoid losing customers and market share - lowering profits; demand is price inelastic when prices fall
demand is price inelastic when prices…
fall
why is there price stability?
• Firms have no incentive to change prices away from profit maximisation, so price stability results
what does the kinked demand curve model?
The kinked demand curve models the behaviour of a firm trying to anticipate the behaviour of its rivals to its actions.
kinked demand curve: what does the elastic part of the demand curve mean?
means a price rise by a single firm above Po lowers total revenue as competitors will not increase their prices and consumers buy their substitute goods.
kinked demand curve: what does the inelastic part of the demand curve mean?
Furthermore, the inelastic part of the demand curve means a price cut below Po also lowers total revenue as other firms copy the price cut to retain their market share.
This leads to the kink in the demand curve and the discontinuous MR curve.
analysis of diagram: why is there price stability?
Because MC crosses the vertical part of the MR curve, a change in costs could lead to lower or higher profits for the oligopoly without impacting the level of output, or the price - which is why there is price stability in oligopoly markets.
analysis: why is there non price competition?
The profit maximising firm will therefore leave price constant, leading to firms engaging in non-price competition.
why is tacit collusion common?
Collusion, particularly tacit collusion, is more likely to take place in an oligopolistic market with a small number of firms because few firms makes it easier to predict responses of other firms to changes in price and output.
why does tacit collusion happen?
if products are similar enough that firms face similar cost conditions it is easier to settle on a price that benefits all firms.
collusion:
what is the issue with high barriers to entry?
high barriers to entry makes price competition by new firms more difficult as they are less able to gain the economies of scale enjoyed by incumbent firms, especially if incumbents drive out new entrants with predatory pricing.
simplified: as a result of high barriers to entry, what does this mean?
firms have high barriers to entry, for example, high start-up costs. As a result, there will be fewer firms in the industry; the market is more concentrated.
simplified: the kinked demand curve
Firms face a kinked demand curve. If they increase price, then other firms will not follow and they will lose sales and market share. This results in price stability due to a desire not to compete on the basis of price, leading to non-price competition.
simplified: when does collusion exist? what does this do?
Collusion exists where firms agree either tacitly or explicitly upon price or output. This restricts competition and maximises the profits which the firm can gain in the industry.
• Firms in an oligopoly market can compete or…
collude
when does price competition occur?
• Price competition occurs when the oligopolistic conditions are weaker:
• There is a relatively large number of firms in the market
• One firm has a cost advantage, and faces lower costs
• Products are good substitutes for each other
• There are relatively low barriers to entry
when does collusion occur?
Collusion occurs when firms cooperate on price or output against the interests of consumers
example of formal/overt collusion:
a cartel, usually illegal
what are the role of strategic alliances?
Strategic alliances, where firms cooperate in a legal way, are often about reducing costs, such as contributing to open-source software, ISO standards, bulk buying (e.g.
Tesco/Carrefour) or sharing networks (e.g. Skyteam - AirFrance, Delta and 17 other airlines). But these can risk investigation from regulators.
why would a dominant firm result in price leadership?
Price leadership, where a dominant firm (such as Saudi Arabia in OPEC) sets a price to see if others follow without the need for overt discussion.
when does collusive behaviour occur?
Collusive behaviour occurs when the oligopolistic conditions are stronger:
• There are relatively few firms in the market
• Firms have similar costs
• Product differentiation, particularly brand loyalty, makes non-price competition more viable
• Barriers to entry are relatively high
what are the 3 advantages of oligopoly?
1) could be dynamically efficient
2) benefits from economies of scale
3) competitive oligopolies raise efficiencies
advantages of oligopoly: dynamically efficient:
Higher profit levels than a more competitive firm means more scope to invest SNP into R&D. It may choose to develop advanced technology or train workers if it knows this will keep barriers to entry high.
advantages of oligopoly: economies of scale
• Few suppliers mean scope for benefiting from economies of scale and achieving a lower average cost. Even making profits, the price charged could be lower than in a more competitive market.
advantages of oligopoly: efficiencies
Competitive oligopolies raise efficiencies
• Output is raised increasing allocative efficiency and competition disciplines the oligopoly lowering the chance of X-inefficiencies
what are the 3 disadvantages of an oligopoly?
1) could be x-inefficient
2) could be dynamically inefficient
3) collusive oligopolies raise prices and output - economically inefficient
disadvantages oligopoly: could be x-inefficient
Lack of competition reduces incentive to reduce excessive stock levels or overstaffing, leading to higher prices for consumers and lower utility
disadvantages oligopoly: could be dynamically inefficient
Lack of competition may mean that it does not reinvest profits to improve the quality of its products
disadvantages oligopoly: Collusive oligopolies raise prices and output - economically inefficient
Productive and allocative inefficiency mean that quantity supplied to consumers is restricted, reducing utility, and at a higher price, further reducing consumer utility - an inefficient use of scarce resources
oligopoly compared to monopoly: positive:
Better than monopoly because more consumer choice and, if competitive, lower prices
oligopoly compared to monopoly: negative:
Worse than monopoly because less opportunity to benefit from dynamic efficiencies and economies of scale
oligopoly compared to monopolistic competition: positive:
Better than monopolistic competition because more chance of benefiting from economies of scale and can achieve dynamic efficiencies in the long run
oligopoly compared to monopolistic competition: negative:
Worse than monopolistic competition if a collusive oligopoly because prices are higher and output restricted leading to fewer consumers benefiting and loss of consumer surplus
define predatory pricing
an anticompetitive strategy in which a firm sets price below average variable cost in an attempt to force a rival or rivals out of the market and achieve market dominance
when may price wars start?
• If one firm sees the opportunity to drive out a weaker competitor, they may lower prices and start a price war
what is the point of a price war?
By lowering prices, the stronger firm is trying to force the weaker firm to leave the market
The incentive is that the stronger firm may be left as a monopoly (or near-monopoly) and increase long run SNP
what does the effect of a price war depend on?
Effect depends on whether the weaker firm has the financial ability to continue during the price war
how does predatory pricing differ to limit pricing
predatory pricing: more extreme, illegal pricing strategy
Limit pricing :less extreme, legal pricing strategy
how do you carry out predatory pricing?
Setting price below AVC, to force other firms out of the market is illegal in the UK and USA
what is the point of predatory pricing?
If price is below AVC, a firm cannot make profit and should leave the market
( This is what courts look for in legal cases to determine if predatory pricing has taken place)
what does limit pricing assume ?
Limit pricing assumes that the incumbent firms) has a cost advantage over potential entrants, such as more economies of scale
in limited pricing, what do incumbent firms choose?
The incumbent firms) can then choose a price below the average cost of potential entrants
what does limit pricing cause?
This deters new firms from entering the market - and competing away profits
- which allows the incumbent(s) to make profits in the long run
how is collusion limited?
Collusion to raise prices may be short lived as firms have an incentive to report involvement in exchange for immunity from fines.
how is a price war limited?
In a price war, although prices may be driven down in the short run, in the long run prices may increase to the original level if all firms survive or to a higher level if a firm leaves the market
what does the likelihood of predatory pricing depend on?
The likelihood of predatory pricing depends on the strength of the CMA (Competition and Markets Authority); the stronger the regulator’s powers of investigation, fines, and authority to grant immunity, the less likely firms are to judge it worth their while
how is limit pricing limited?
Limit pricing benefits consumers in the short run with lower prices but may lower choice in the long run
