3.4.4 Flashcards
define an oligopoly
An oligopoly is a market dominated by a few producers, each of which has control over the market.
what are the 4 charactertics of an oligopoly?
- high barriers to enter and exit the market
- high concentration ratio (combined market share of first 5 firms is more than 60%)
- interdependance of firms
- product differentiation
define interdependance
firms must consider the likley reactions of existing competitors to changes in thier prices or forms of non price competition such as marketing and advertising spending
Draw kinked demand curve
if a firm charges higher prices rival swill not follow as they try to undercut, if a firm lowers prices then so will others and will probs lead to price war
how does kinked demand curve show price rigidity?
At P1 Q1 the any change in output will lead to a fall in revenue. Also rise in MC (within the gap) might not cause a change in price, keeping P1 Q1 as maximising profit level.
this demonstates price rigidity and instead a firm may compete on non price factors such as branding and marketing as a form of protecting existing market share and supernomal profit.
what are the types of non price competiton that oligopolies may use?
- innovation
- quality of service- including after sale service
- loyalty schemes–> consumer loyalty
- branding: marketing and advertsing
- sales promotions: eg: free shipping
eg: sky spend £124 million a year
draw the cost revenue diagram to show the effect of increased spending on advertising and marketing
- Many firms use it to reinforce their market share and also to make demand for their products less price elastic. They do this by using marketing to increase brand loyalty.
- Successful advertising causes an outward shift in AR and MR and allows a firm to sell more product at higher prices. Strong brand loyalty reduces the coefficient of PED which in turn allows firms to sell at higher profit margins.
- But advertising is also a cost – we normally treat it as a fixed cost. For example, a one-off marketing campaign must be paid for regardless of the short-run level of output.
- A rise in fixed costs causes average total cost to shift upwards but there is no change in marginal cost since this is affected only by variable costs.
- ev:Many firms make smart use of digital marketing including viral adverts and use of influencers on social media. Change in profits depends on effectiveness of advertsing and marketing
define collusion
- an agreement, between competing firms to coordinate their actions to reduce competition and maximize joint profits
what are the benfits of collusion?
- maximise joint profits
- lowers cost of competition. eg: wasteful marketing wars
- reduces market uncertainty: agree to limit production to keep prices high and avoid oversupply.
How is reduced market uncertaintity beneficial to firms? (oligopoly)
include evaluation points
- making long term investments with greater confidence
- stable revenue streams and profit margins improve financial health, making it easier for firms to secure lower intrest rates
- controlled output means firms avoid cost of overproduction. eg: excess inventory
EV
* illegal, risk of fines
* moral hazard: becoming lazy and not being dynamically efficent
* changes in consumer prefernces/ technological advancements can undermine collusive agreements, reintroducing uncertainity
what are are the reasons for non-collusive behviour?
- legal reprocussions: those proved to be within a cartel can face imprisonment and unlimited fines
- unstable because firms have an incentive to cheat by secretly lowering prices or increasing output to capture a larger market share.
*
what is the n- firm concentration ratio calculation?
measures the combined market share of the largest n firms in an industry
The higher the concentration ratio, the less competitive the market, since fewer firms are supplying the bulk of the market.
define overt collusion
Occurs when firms openly agree to cooperate and set prices or output levels.
“open”
define tacit collusion
Involves firms behaving in a manner that resembles collusion without any explicit agreement.
define cartel
A cartel is a formal agreement among firms on things such as prices, total industry output, market shares, allocation of customers
show price collusion on a cost revenue diagram and why cartels are likley to collapse
Although the cartel as a whole might be maximising joint profits, each individual firm could increase their own profits by expanding output and undercutting the cartel price by a small margin. This is often one reason why cartels are undermined and eventually collapse – namely, cheating on output quotas by cartel members.
what is price leadership?
Price leadership is a concept in the theory of oligopoly where one firm in the industry takes the lead in setting or changing prices, and other firms in the industry follow this leader’s pricing strategy.
what are the 3 types of price competition?
- predatory pricing
- limit pricing
- price wars
what is predatory pricing?
the practice of setting prices below the cost of production, with the intention of driving competitors out of the market.
Once the competition is eliminated, the predator can then raise prices to a more profitable level.
what is limit pricing?
The idea is that the existing firm sets its prices at a level that is low enough to discourage new firms from entering the market, but high enough to still be profitable for the incumbent firm.
Explain how a firm may use predatory pricing
analysis, diagram, eval
- Predatory Prcing is a delibertate strategy of driving out competitors out of the market by setting very low prices or selling below AVC.
- The aim of predatory pricing is to reduce competition and increase the monopoly power and profit of firms who benefit from it.
- Predatory pricing can be used by both existing firms and new entrantsin a market.
- Established firms may decide that they can absorb losses for a short while by drastically cutting their prices below AC or even AVC
- As a result they are able to pick up a lot of market share from the other suppliers in the market.
- The losses are shown in the shaded area
- But if preadtory pricing is successful, then monoply power is built up and the firm can use their market dominance to increase prices in the long run to achieve a higher level of supernormal profit
Explain how a firm may use limit pricing
analysis, diagram, eval
- limit pricing is defined a pricing by the existing firm to deter the entry of new firms.
- limit pricing is designed to act as a barrier to enter market in order to protect a firm’s monopoly power/ super normal profit.
- The limit price is below the profit maximsing price but above the competitive level.
- The monopolist is charging a lower price than the estimated AC for a rival, willing to sacrifice profits in the short run to prevent entry
- As a result the potential rival firm may decide that the risks of entering the industry are too high, as they make a sizable loss and may not have the resoucres to sustain those losses until they reach a competitive level of economies of scale
- If limit pricing is sucessful then a market is likley to remian highly concentrated in the hands of one or a small number of dominant firms who continue to earn supernormal profit as P> AC.
Explain the simple game theory matrix
the dominant strategy for firm A will be to choose lower prices , likewise will firm B becuase 12 and 7 is better than 10 and 3.
* this leads to equilibrium at £7 each, both charging low prices
* yet if both were to collude and fix high prices then they both could benefit and make a profit of £10 (joint profit maximisation)
* however price collusion can be fragile as both firms are incetivsed to undercut the high prices and charge lower prices in order to make £12 profit
* in the long run both may do so leading to initial equilibrium of £7
describe price stability in an oligopoly
- in an oligopoly firms have price setting power but may be reluctant to use it
- rivals are unlikley to match a price rise but rivals are likley to match a price fall
- if a firm is settled on one price, there may be little point in changing it
- even if costs change we often see price rigidity in an oilgopoly
- this increases the importance attachted to non price competition in an oligopoly
