3.4.4 Oligopoly

Question 1

Oligopoly characteristics

Answer 1

• Few firms dominate the market- high conc ratio
• Differentiated goods- firms are price makers
• High barriers to entry/ exit due to startup costs, E.O.S, subcosts, brand loyalty
• INTERDEPENDENCE= price rigidity: firms make decisions based on actions and all the reactions of rival firms
• Non- price competiton- competition based on branding, advertising, quality of G/S
• Profit maximisation isnt sole objective- revenue maximisation

Question 2

How do you know whether an oligopoly exists in terms of concentration ratio

Answer 2

An oligopoly exists when the top five firms in the market account for more than 60% of total market sales.

Question 3

If top 5% have greater than 60%= oligopoly

Example of oligopoly

Answer 3

Electricity market CR3 - 70%

Question 4

Define market concentration ratio

Answer 4

% of total market a particular number of firms have

Question 5

What does high concentration ratio mean

Answer 5

• High market share of some firms
• Few large firms dominate
• Uncompetitive

Question 6

Differing price elasticities of D around the price in the market of P1

Explain the kinked demand curve

Answer 6

• Inrease price- price elastic D curve so Q falls by a large amount and due to interdependence, firms will not follow this price increase so market share and TR fall
• Decrease price- price inelastic D curve so Q increases by a lesser amount and other firms will follow which lead to price wars so TR falls and no change in market share

Question 7

Using game theory, discuss the effects on firms of cutting P’s in an oligopolistsic market

Answer 7

• Firms are independent so they will respond in the face of what other firms might do
• Firms may not reach same outcome as if they operated alone
• Firms are decreasing P’s want to expand market share and steal other firms markets
• All firms responding this way –> firms make less profit overall
• Price cuts —> form of limit pricing= decrease contestability

Question 8

Using game theory, evaluate the effects on firms of cutting P’s in an oligopolistsic market

Answer 8

• Firms may have signifcant market share and brand loyalty. Even if competition lowers prices, thet may not switch
• No sign on interdependence? Firms are cuting P’s may not due to regulation and not because of actions of other firms

Question 9

Define anticompetitive behaviour

Answer 9

Anticompetitive behaviour is when a firm acts in a manner which is harmful to the both consumers and other firms in the industry.

Question 10

Define collusion

Answer 10

When 2 or more firms agree to limit competition

Question 11

Overt collusion

Answer 11

A formal agreement between firms to collude.
Avoid competition by fixing higher prices–> bad for consumers. This is illegal.

Question 12

Tacit collusion

Answer 12

An unspoken agreement between firms to collude.
Instead, firms monitor each other’s behaviour closely.

Question 13

Define cartel

Answer 13

An extreme form of collusion. A formal agreement between firms to limit competition in the market, for example by limiting output in order to raise prices.

Question 14

Price leadership

Answer 14

A form of tacit collusion. This is when one firm, the price leader, sets its own prices and other firms in the market set their own prices in relationship to the price leader.

Question 15

Type of price competition

Limit pricing

Answer 15

Limit-pricing occurs when a firm operates below the profit maximising output of MC = MR. The firm will still make a profit but potential entrants will be deterred from entering the market as lower price means that entry is not profitable
Incumbent firms uses its E.O.S= lower AC= lower P’s

Question 16

Type of price competition

Price wars

Answer 16

Price wars occur when a firm lowers price in order to increase market share. Other firms will react to losing market share by lowering price too. This will continue as firms seek to regain lost market share. The consumer will benefit from lower prices but the oligopolists will lose out as overall revenues will fall

Question 17

Type of price competition

Predatory pricing

Answer 17

Predatory pricing occurs when a firm attempts to force competition out of the market by setting low prices. This might be below average cost in the short run and is likely to see increased output as demand is higher
P<AVC (below SR shut down point AR=AVC), which means firms are just covering their variable costs
Lower P= entry not profitable

Question 18

Types of non-price competition

Answer 18

• Advertising- this will raise awareness, interest, desire and action to increase sales of G/S
• Branding- investing in the image, logo, slogan of the business- to build trust amonst conumers

Question 19

Explain why an incumbent firm might pursue a strategy of limit pricing.

Answer 19

• Limit pricing is a pricing strategy used by an incumbent firm - which involves setting price at a level which makes it difficult for new firms to make a profit - in order to deter new firms from entering the market.
• Limit pricing is effective if the incumbent is able to set a price just below the average total cost of potential new entrants, which means that new firms cannot make a profit at the incumbent’s low price.
• The incumbent can sustain a low price strategy, as long as its revenue is making some contribution towards fixed costs.

Question 20

Why might firms not want to collude

Answer 20

Due to the risk of regulation within the energy market such as Ofgem and CMA enforce rules to avoid the formation of monopolies and maximise social welfare so consumers are not exploited

Question 21

Why would a firm not engage in predatory pricing

Answer 21

However in many countries (including the UK), predatory pricing is considered an anti-competitive practice and is illegal to use, if a firm were caught using this pricing strategy they would be imposed large fines and
would lose a large amount of their revenue.

Question 22

Effect of loyalty card

Answer 22

• By introducing loyalty cards for frequent customers, the firm will have an incentive for customers to continue to visit their location, increasing demand for the long run.
• A loyalty card would also prevent customers from visiting other firms as they have an incentive to continue visiting their firm due to the rewards they could reap from being a frequent visitor
• This would lessen competiton and increase sales