3.4.4 Oligopoly

Question 1

Oligopoly

Answer 1

A market dominated by a small number of firms with high barriers of entry, in which firms offer differentiated products.

Question 2

Examples of oligopolies

Answer 2

Banks, insurance companies, department stores, supermarkets, petrol retailers, etc.

Question 3

A market is said to be an oligopoly if it has a 4-firm concentration ratio of…

Answer 3

60% or more

Question 4

What does it mean if a market has a 4-firm concentration ratio of 60%?

Answer 4

The market share of the top 4 largest firms in the market is 60% or more.

• This is not a definitive amount; it is just a general rule of thumb.

Question 5

What does it mean if a firm offers differentiated products?

Answer 5

The products offered by different firms will be similar but not identical.

Question 6

What are the conditions for an oligopoly?

Answer 6

• The market is dominated by a few firms (with a high concentration ratio).
• The market has high barriers to entry, meaning new entrants cannot easily compete away supernormal profits.
• Firms offer differentiated products.
• Firms are interdependent.

Question 7

What is a concentrated market?

Answer 7

A market which is dominated by a few companies.

Question 8

What do concentration ratios do?

Answer 8

Show how dominant the big firms in a market are.

Question 9

What would a one-firm concentration ratio of 100% be?

Answer 9

A natural monopoly.

Question 10

Competitive behaviour

Answer 10

This is when the firms don’t cooperate, but compete with each other (especially on price).

Question 11

Collusive behaviour

Answer 11

This is where firms cooperate with each other, especially over what prices are charged

Question 12

What are the two types of collusive behaviour?

Answer 12

• Overt (formal)
• Tacit (informal)

Question 13

Overt (formal) collusion

Answer 13

Involves an agreement between firms – usually by forming a cartel. This is illegal.

Question 14

Tacit (informal) collusion

Answer 14

This happens without any kind of agreement. This happens when each firm knows it is in their best interests not to compete – as long as all other firms do the same.

Question 15

Competitive behaviour is more likely when…

Answer 15

• One firm has lower costs than the others.
• There’s a relatively large number of big firms in the market (making it harder to know what everyone else is doing).
• The firms produce products that are very similar.
• Barriers to entry are relatively low.

Question 16

Collusive behaviour is more likely when…

Answer 16

• The firms have similar costs.
• There’s a relatively few firms in the market (making it easier to check what other firms are charging, etc.).
• Brand loyalty means customers are less likely to buy from a different firm, even when their prices are lower.
• Barriers to entry are relatively high.

Question 17

What do collusive oligopolies lead to?

Answer 17

• Higher prices and restricted output.
• Allocative inefficiency.
• Productive inefficiency.

Question 18

Do collusive oligopolies achieve dynamic equilibrium?

Answer 18

Firms have the resources to invest in more efficient production methods, however there’s not always an incentive for them to do so.

Question 19

Why do firms in collusive oligopolies make supernormal profits?

Answer 19

They don’t lower prices, even though they could - they make supernormal profits at the expense of consumers.

Question 20

How could collusive oligopolies compete in ways other than price?

Answer 20

• For example, colluding firms may try to differentiate their products from their competitors’ – either by improving them in some way or by trying to create a strong brand to attract and retain customers.
• They could use sales promotions (e.g. ‘loyalty’ rewards for customers who make repeat purchases).
• They may even try to find new export markets.

Question 21

Predatory pricing

Answer 21

Where incumbent firms drive new competition out of the market before it becomes established.

Incumbent firms may be able to lower prices to a level that a new entrant cannot match (e.g. due to economies of scale) and drive them out of business.

Question 22

Benefits of oligopolies

Answer 22

Competitive oligopolies:
- Non-price competition can lead to dynamic efficiency (which would increase innovation and improvements in products).
- Firms are unlikely to raise prices to very high levels (because prices may incentivise new entrants to join the market, even if the barriers to entry are high).

Collusive oligopolies:
- Can achieve high levels of efficiency.

Question 23

Is collusion always bad for consumers, and is it likely to happen?

Answer 23

Some economist argue that overt (formal) collusion is unlikely to occur because it is illegal, and any tacit (informal) collusion is likely to be temporary, because one firm will soon decide to cheat, and lower its prices to gain an advantage - likely triggering a price war (and falling prices).

Question 24

Game theory

Answer 24

• Game theory is a branch of maths.
• It involves analysing situations where two or more ‘players’ (e.g. people, firms, etc.) are each trying to work out what to do to further their own interests.
• The fate of each of the players depends on their own decisions, and the decisions of everyone else. So all the players are interdependent. This is why it’s often used to analyse situations in economics.

Question 25

What can the the prisoners’ dilemma model be used for?

Answer 25

Understanding how interdependent firms might act in an oligopolistic market. In the version below, there are two firms:

Question 26

[Flashcards about game theory]

Question 27

Is it an advantage or disadvantage to being the first mover in game theory?

Answer 27

It depends -

• The first mover could make a huge profit by winning a large market share very early.
• However, if they’ve overestimated the demand for the product, they may make huge losses.
• Also, competitors may be able to use a lot of the technology that the first firm has developed, reducing their costs, and allowing them to charge a lower price than the first mover.