3.4.4 - Oligopoly

Question 1

Blurt all the characteristics of an oligopoly that you know

Answer 1

• High barriers to entry and exit - this makes the market less competitive.
• High concentration ratio - Small number of large firms. The high concentration ratio makes the market less competitive. Include the concentration ratio)
• Interdependence of firms - Firms are interdependent in an oligopoly. This means that the actions of one firm affect another
  firm’s behaviour.
• Product differentiation - All goods must be similar but slightly different.

Question 2

Real life example of oligopolies.

Answer 2

The fizzy drink market:
- Coca cola and pepsi
The supermarket industry :
- Sainsbury, Tesco, Asda, Lidl and aldi
(In 2025 upload their market share)

Question 3

Game theory
- Diagram
- What is it used for ?
- Explain the diagram

Answer 3

• It’s used to explain the interdependence of firms.
• The left value is always the firms on the left sides payoff.
  1. If both firms play high price (collision) then they will see high revenues and therefore high prices.
  2. However if one firm cheats on a collusion agreement and sets lower prices then that firm will attract more customers and experiences even higher revenues and profits that if they didn’t cheat on the collusion agreement. There is always a temptation to break an agreement either to maximise a firm’s sales by lowering prices and catching a rival unaware or to gain immunity from prosecution by acting as a whistle-blower and informing the competition authorities about any collusive agreement. However this means that the other firm will loose out on revenue and profits.
  3. In response the other firm will then also lower their prices a price war may the break out until films are at a price where its unprofitable.

Question 4

Why might firms collude ?

Answer 4

• If they collude and set a high price, then they will both double their profits and make £8m.
• This shows a significant incentive to collude to reduce competition and achieve higher supernormal profits.
• The combined total pay off is the greatest where firms collude - this is therefore the optimal outcome (even though it is illegal)
  This would mean the firms are now acting more like a monopoly and can charge a higher price maximising supernormal profits
  When oligopolistic markets behave in this way.
• There is a loss of welfare for consumers - reduce consumer surplus Collusion is most likely where there is a high concentration ratio so organising and fixing prices between the two biggest competitors would not be hard.

Question 5

Evaluation points for the likelihood of collision happening

Answer 5

Question 6

How do you explain a price war ?

Answer 6

When firms keep undercutting each other to earn a higher pay off

Question 7

What is collusion ?

Answer 7

When two or more firms agree to set prices high or fix the quantity of output they produce which limits competition

Question 8

What is non-collusive behaviour ?

Answer 8

When firms are actually competing.

Question 9

Name the two types of collisions.

Answer 9

• Over collusion
• Tacit collusion

Question 10

Blurt everything you know about is overt collusion ?

Answer 10

• When a formal agreement is made between firms t
• It works best when there are only a few dominant firms so one firm doesn’t refuse the collusion.
• Its illegal in the EU and US
• It is often suspected that fuel companies take part in this.
• It can be in the form of price fixing which maximises their joint profits and cut the cost of competition e.g less advertising and R&D, it desinectives firms to be productive and efficient.
• It leads to lower consumer welfare.
• Only over collusion is illegal

Question 11

What is a cartel ?

Answer 11

• A group of two or more firms which have agreed to control prices, limit output or prevent the entrance of new firms in the market.
• This is an example of overt collusion

Question 12

Example of a cartel.

Answer 12

• OPEC, which fixed their output of oil.
• This was possible since they controlled over 70% of the supply of oil in the world.

Question 13

Cost and benefits of cartel tabel

Answer 13

Question 14

What is a tactic collision ?

Answer 14

• An unspoken collusion between firm - We see this through price leadership where the market leader who has the strongest brand or benefitting the most from economies of scale will set the price.
• This is because the dominant firm benefits from large economies of scale and therefore cannot be beaten price wise by the smaller firms. Therefore, all the smaller firms follow the prices that the price leader sets.

Question 15

Name the three types of price competition

Answer 15

• Price wars
• Predatory pricing
• Limit pricing

Question 16

Reasons for non-collusive behavior

Answer 16

• Low barrier to entry :
• Cost advantage : This is because if one firms benefit from economies of scale they can drive out competition though lowering their prices that other firms can’t compete with and become a monopoly.
• Homogeneous goods : If there are homogenous goods within a market then firms lack the price making powers in
  order to fix prices. This is seen in the perfectly competitive market diagram where average
  revenue and marginal revenue curves are completely elastic.
• Saturated market : In saturated markets there is lots of competition that takes place, usually in the form of
  price wars. Firms may participate in price wars in order to get ahead of each other and gain
  market share. As a result of this, there is a higher chance of collusive firms cheating and not
  sticking to the original agreement. Therefore, collusion is often avoided in saturated
  markets.

Question 17

Blurt everything you know about price wars
inc. Examples

Answer 17

-When firms lower their prices in an attempt to
undercut each other and gain market share.
- Supermarkets, Low cost airlines (e.g wiz, easy jet, ryan air)
- Winners :
0 Consumers as they benefit from lower prices in the short tun.

• Losers :
  0 Firms as they may suffer from loss of profit in the short run, but they will continue to produce if their AVC is below AR.
  0 Consumers may face higher prices in the long run when all competition is pushed out

Question 18

Blurt everything you know about predatory pricing.
Inc. examples

Answer 18

• Its illegal in the UK
• This is when firms push prices below AVC (below their shut down point) to force rivals out of the market. They can then raises prices again.
• This is a very anti competitive market and can lead to fines by the competition authorities.
• Busways (a new entrant into the bus market) offered free bus rides to try and force their competitor, Darlington Transport Company, out of business.

Question 19

Blurt everything you know about limit pricing.
Inc. examples

Answer 19

• When an incumbent firm uses economies of scale to set a price low enough to limit the number of firms entering
• Small new firms don’t benefit from economies of scale so won’t be able to compete or make a profit and therefore stay out of the market.
• firms will often choose to operate at a point below profit
  maximization. By doing so, they only make normal profits in the short run and therefore don’t face the increased competition caused by new entrants into the market
• This happens via economies of scale

Question 20

Name the 4 main types of non-price competition

Answer 20

1. Advertising
2. Quality of the product/service
3. Loyalty cards

Question 21

Blurt everything you know about advertising (non-price competition)

Answer 21

• firms are able to build themselves a
  brand. Having a strong brand enables firms to increase the amount of sales that they gain,
  thus increasing their competitiveness within the market.
• Increase brand awareness
• However for some firms this may be ineffective and lead to them incurring large sunk cost, which are unrecoverable

Question 22

Blurt everything you know about quality (non-price competition)

Answer 22

• Firm’s that produce high quality products or offer high quality service can gain a competitive advantage over other firms within the market. This can be seen with supermarket chains such as Waitrose. Although their prices may be higher than supermarkets such as Aldi, they gain customers by offering higher quality food products and a better customer experience.
• However they can only do this if AR>AC

Question 23

Blurt everything you know about loyalty cards (non-price competition)

Answer 23

• Loyalty cards can be a good way of encouraging repeat customers and therefore a regular
  flow of revenue into the firm. These loyalty schemes have become popular in retail industries, with large firms such as Tesco, Waitrose and the Co-Op using them. By doing so
  they are likely to gain more loyal and customers than those supermarkets that loyalty cards.

Question 24

What factors are likely to promote competitive vs collusive oligopoly
- Table

Answer 24

• Therefore if the oligopoly you have investigated is competitive – the benefits and drawbacks of a competitive market will apply
• However, if it is a collusive monopoly – the benefits and drawbacks of a monopoly will apply. This applies to tacit and overt collusion.

Question 25

What do you know about dynamic efficiency in an oligopoly.

Answer 25

Note: This can be used to explain benefits of oligopolies
- Dynamic efficiency - where supernormal profit is being made. Where firms collude there is the potential to make even bigger supernormal profits. Such profit can then be reinvested back into the company in the form of technological advances, R&D, and innovative new products.
- This could lead to more choice and lower prices over time, high consumers satisfaction, maximising utility and consumer surplus.

Example:
- Pharmaceuticals - supernormal profits are essential for these industries to be able to fund R&D into new treatments and drugs. This has wider positive externalities for society e.g. development of vaccines/cures for life threatening illnesses.

• Hi tech industries - supernormal profits are essential for software developers/social media markets. New products that save us time/money.

Question 26

What do you know about allocatively efficiency in an oligopoly.

Answer 26

• There is no allocatively efficiency
• As firms collude to keep prices above the allocatively efficient level.
• where collusion exists - pricing above marginal costs. Loss of consumer surplus. Consumer choice is also restricted.

Question 27

Some benefits of Oligopolies

Answer 27

• Even though collusion leads to productive inefficiency due to a lack of competition - these large firms with significant market share are still able to exploit greater economies of scale than smaller competitive firms who have lower levels of output. Leading to lower average costs and lower prices for consumers.
• More Competitive oligopoly markets could also be more productively efficient producing near or at the lowest point on the AC curve.
• Increasing choice through competing on non price factors can maximise consumer satisfaction/utility

Question 28

Some drawbacks of Oligopolies

Answer 28

• They are Allocatively inefficient This happens where collusion exists - pricing above marginal costs. Loss of consumer surplus. Consumer choice is also restricted. This is because when firms collude the set prices above the allocatively efficient level.
• Lack of competition leads to productively and x inefficiency as there is no incentive to reduce costs in order to lower prices and be more competitive.
  when colluding.