3.3 Monopoly and oligopoly Flashcards
What are the characteristics of an oligopoly?
- High market concentration
- High barriers to entry
- Top five firms account for over 60%% of ratio
- Price rigidity, non price competition, interdependent decision, attempts to collude and fix prices
What are the key assumptions?
- Dominated by few large firms with large market shares
- High market concentration
- Each firm suppplies branded products, differentiated and strong brand loyalty
- High barriers to entry/exit
- Interdependent decision by firms
- Price makers, may collude
What is interdependence?
- One firm’s output and decisions influenced by likely behaviour of another
- Few sellers means each firm likely to be aware of actions of others
- Decisions are influenced by other firms
- Oligopolistic industries at risk of tacit or explicit collusion
- In oligopoly always high level of uncertainty
What is the concentration ratio?
Combined market share of top n firms in the industry, often 5 or 3 - if 5 firm greater than 60% it is an oligopoly
What is non collusive behaviour in an oligopoly?
Innovation, quality of services, upgrades of products, sale promotion, advertising, loyalty schemes
Focus on quality of product, design look and feel, environmental impact, after sales services, other marketing factors such as branding and advertising
What are the reasons for collusive behaviour?
- Recognise interdependence and act together to maximise joint profits
- Lowers cost of competition
- Reduces uncertainty
What is legal collusion?
- Practices not prohibited if contribute to improving production or distribution of goods
- Development of industry standards benefit consumer
- Information sharing gives better information to consumers
- Research joint ventures and agreements promote innovation and inventive behaviour in a market
What is overt collusion?
- Spoken or traceable collusion where they openly work together and agree on prices - rare as CMA prevent this and see high penalties if found out.
- Desire to achieve joint profit maximisation in a market or prevent instability
- Price fixing attempts to control supply and fix price at a level close to monopoly levels
- Producers need control over supply to agree a price.
What is tacit collusion?
Firms observe each others behaviour closely and match prices without communication, may emerge over time and be done through price leadership as one firm may take the lead in setting the prices.
Why may cartels happen in an oligopoly?
- Industry regulators ineffective
- Penalties for collusion are low
- Few firms in market had inelastic demand - higher prices higher revenues
- Firms have high percentage of total sales so can control market supply
- Firms communicate well and trust each other
- Products standardised and output within cartel easily measurable so supply can be control
- Brands strong so consumers do not switch when collusion raises prices
- Strong barriers preventing consumers to switch to alternatives?
Why do cartels break down?
- Enforcement problems - aims to restrict production to maximise profits but each seller finds it profitable to expand production
- Other firms sell under cartel price
- Falling market demand e.g. recession
- Entry of non cartel firms
What are the costs and benefits of collusive behaviour?
Costs:
- Damages consumer welfare - high prices, low consumer surplus, loss of allocative efficiency, more inequality
- Lack of competition reduces efficiency - X inefficiency, less incentive to innovate, output quotas penalise firms who want to expand
- Reinforces cartel’s monopoly power
Benefits:
- General industry bring social benefits - pharmaceutical research, safety
- Fairer prices for producer helps lower and middle income developing countries - compete more effectively with powerful corporations with monopsony power
- Profits have value - R&D and higher wages for employees
What is game theory?
A model that assesses the behaviour of businesses in oligopolistic markets. For instance, firms may decide to raise output or lower output, considering firm A and firm B.
For instance, if firm A and firm B both choose not to change output, both indexes remain at 100
If firm A decides to raise output but firm B does not, the index of firm A will rise to 130 but firm B will fall to 40 - and vise versa if B rises and A does not
If both decide to rise outputs, then both outputs go to 70 so both lose out
Is game theory relevant?
- Analysing business decision making when there are few firms
- Standard game theory assumes rational agents looing to maximise self interest
- More complex theory reveals businesses develop cooperative and collaborative behaviour and rise of joint ventures
- Game theory over simplifies complex decisions - when there are more than two rival firms the complexity increases
- Many firms fall back on rules when making decisions and other decisions
What is the kinked demand curve?
As firms anticipate actions of other firms, the demand curve has a kink as there is a point where when if one firms decides to cut costs and others follow, it will create an inelastic segment of the demand curve which could have previously been elastic.
This leaves firms with the dilemma as if they choose to increase prices it will be more inelastic so they may see profit but also consumers may just switch - if they choose to cut prices it is also inelastic so will not see profit wanted.
