3.4.4: Oligopoly Flashcards

1
Q

What is an oligopoly?

A

A state of limited competition where there are a few firms that dominate the market share.

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2
Q

What are the characteristics of an oligopoly?

A

-High concentration ratio (indicates that a few firms produce the majority of the industry’s output).
-Interdependency (the actions of one firm directly affects another).
-Differentiated goods.
-High barriers of entry/exit.

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3
Q

What is the n-firm concentration ratio?

A

Total Sales Of N Firms / Total Sales Of Market X 100

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4
Q

What is collusion/collusive behaviour?

A

When firms make collective agreements to avoid competition (e.g. price competition).

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5
Q

Why would firms engage in collusion/collusive behaviour?

A

-Reduces the uncertainty firms face of competitive price cutting, which reduces profits.
-Leads to higher prices, lower consumer surplus, and greater profits for colluding firms.

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6
Q

Why would firms avoid collusion/collusive behaviour?

A

-Collusion is illegal, and there is a risk of firms breaking the agreement.
-A firm with a strong business model will not want to collude if they feel as if they can increase market share.

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7
Q

At what conditions does collusion work best in?

A

-Few firms that are well known to each other.
-Firms aren’t secretive about costs and production methods.
-Similar costs and production methods.
-Stable market.

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8
Q

What is overt collusion?

A

When a formal agreement is made between firms.

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9
Q

What is tacit collusion?

A

When firms coordinate without an explicit agreement.

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10
Q

What is a cartel?

A

A group of two or more firms which have agreed to control prices or prevent new firms from entering the market.

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11
Q

What is price leadership?

A

When a dominant firm changes their prices, and other firms follow.

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12
Q

What are advantages of collusion?

A

-Industry standards can improve as firms collaborate on technology and improve it.
-Excess profits can be invested, improving efficiency in the long run.
-Firms can exploit economies of scale through increasing its size.

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13
Q

What are disadvantages of collusion?

A

-Loss of consumer welfare as prices are raised and output is reduced.
-Reinforces the monopoly power of existing firms, making it hard for new firms to enter.

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14
Q

What is an example of (overt) collusion?

A

The Organization of the Petroleum Exporting Countries (OPEC) is a cartel of oil-producing countries which was established in Baghdad, Iraq, in 1961.
OPEC owns more than 80% of total global crude oil reserves, and around 48% of global natural gas reserves.

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15
Q

How does game theory link with oligopolies?

A

Game theory refers to the interdependence of firms, predicting the outcome of a firm when they have incomplete information about another identical firm.

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16
Q

Example of game theory:

A

Prisoners.

17
Q

What is nash equilibrium?

A

The optimal outcome for a firm based on the expected decision of the other firm.

18
Q

What is dominant strategy?

A

The option that has the best outcome, regardless of the other firm’s decision.

19
Q

What conclusions can occur from game theory?

A

-Price rigidity (leading to non-price competition).
-Temptation to collude (profit maximisation).
-Incentive to cheat on collusive agreement (short term profit, or fear of competition authorities).

20
Q

What are the three types of price competition?

A

-Price wars.
-Predatory pricing.
-Limit pricing.

21
Q

Features of price wars:

A

-Occurs in markets where non-price competition is weak (goods have weak brands and consumers are price conscious).
-Potentially drives prices down to levels where firms are frequently making losses.
-Lowers industry profits.

22
Q

Features of predatory pricing:

A

-Occurs when an established firm is threatened by a new entrant, or 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 are driven out of the market.
-This is illegal, and only works when a firm is large enough to have low prices and sustain losses.

23
Q

Features of limit pricing:

A

-Firms will set low prices (high enough to at least make normal profit) to prevent new entrants.
-The greater the barriers to entry, the higher the limit price.
-Firms can’t make profits as high as wanted.

24
Q

Example of price wars:

A

Supermarkets.

25
Q

Example of predatory pricing:

A

Amazon.com with Diapers.com.

26
Q

What are the types of non-price competition?

A

-Advertising.
-Loyalty cards.
-Branding.
-Quality & customer service.
-R&D.

27
Q

(Oligopoly) In the long term, are firms:
-Allocatively efficient?
-Productively efficient?
-Dynamically efficient?

A

-No.
-No.
-Yes: firms make supernormal profits, so they can invest, and have incentives to do so due to competition.