3.4.4 - oligopolies Flashcards
what is an oligopoly
Oligopoly is where there are a few firms that dominate the market and have the majority of market share, although this does not mean there won’t be other firms in the market.
what are the characteristics of an oligopoly
There are four key characteristics of oligopoly: products are generally differentiated; supply in the industry must be concentrated in the hands of a relatively small number of firms, meaning there is a high concentration ratio; firms must be interdependent (so the actions of one firm will directly affect another); and there are barriers to entry.
describe kinked demand in an oligopoly.
kinked demand is used to show the interdependence of firms. if one firm raises its prices, the others will not follow as they know that they have more competitive prices. however If one firm decreases the firms will follow and do the same
what is collusion in oligopolies
Collusion is when firms make collective agreements that reduce competition. When firms don’t collude, this is a competitive oligopoly. The UK energy market is an oligopoly that is suspected of collusion.
what is tacit collusion
this occurs when firms make subtle hints to engage in collusion
what is overt collusion
this is where firms make secret agreements to collude
what are the reasons for collusion
higher prices mean higher profits for the firm. it also mean they don’t have to spend money on cutting costs if they can raise prices. they can also pay shareholders more which attracts more investors which pushes up the stock and makes people richer
what is game theory
it is a diagram used to demonstrate the interdependence of firms with their pricing. usually the dominant strategy is to always price low as this will prevent the firm from being undercut so this will be the dominant strategy
why do firms get involved in price competition
to get rid of firms in the market
what are price wars
● These occur in markets where non-price competition is weak; where goods have weak brands and consumers are price conscious. They also occur when it is difficult to collude.
● A price war will drive prices down to levels where firms are frequently making losses. In the short term, firms will continue to produce if their AVC is below AR but in the long run, they will leave the market and prices will have to rise since supply falls.
● It lowers industry profits.
● Supermarkets are one example of an industry using heavy price wars, with firms
desperately trying to offer lower prices than their rivals.
what is limit pricing
● In order to prevent new entrants, firms will set prices low (the limit price). The price needs to be high enough for them to make at least normal profit but low enough to discourage any other firm from entering the market.
● The greater the barriers to entry, the higher the limit price. It is mainly used in
contestable markets.
● The drawback of this is that it means firms cannot make profits as high as they would be otherwise be able to.
pricing where ar=ac
what is predatory pricing
● This occurs when an established firm is threatened by a new entrant or if one firm feels that another is gaining too much market share.
● The established firm will set such a low price that other firms are unable to make a profit and so will be driven out the market. The existing firm is then able to put their price back up.
● This is illegal and only works when one firm is large enough to be able to have low prices and sustain losses.
