3.4.4 Oligopoly Flashcards
LS13
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How to calculate n-firm concentration ratio?
- Market share of n largest firms in an industry
- Can be calculated on basis of shares in output or shares in employment
e.g. three-firm CR = market share of 3 largest firms in industry
Drawbacks of calculating concentration ratio on basis of shares in employment?
- Largest firms in industry may be more capital-intensive in their production methods = share of employment in industry < share of output
Oligopoly market definition?
- A market with just a few sellers where the firms are interdependent
Characteristics of oligopoly market?
- Few large firms
- High barriers to entry
- Products can be differentiated or homogenous
- Mutual interdependence between firms
High barriers to entry characteristic for oligopoly market?
- Economies of scale - makes it difficult for new firms to compete due to high costs (e.g. aircraft industry, patents, control of natural resources)
- High start-up costs - enormous sums spent on product differentiation and advertising by existing firms = difficult for new firms to match such expenditures
Mutual interdependence characteristic for oligopoly market?
- Decisions by one firm affect other firms in industry so interdependent
- Firms are keenly aware of actions of rivals
- Leads to strategic behaviour and conflicting incentives
Strategic behaviour in oligopoly market?
- Plans of action that takes into account rivals’ possible courses of action
Conflicting incentives in oligopoly market?
- Firms in oligopoly face incentives that conflict with each other
- Incentive to collude
- Incentive to compete
Incentive to collude in oligopoly market?
- Refers to an agreement between firms to limit competition - by fixing price and lowering Q produced
- Reduces uncertainties, maximises profits
Collusion is illegal and gets fined by CMA (apart from OPEC)
Incentive to compete in oligopoly market?
- Firms face incentive to compete with rivals to capture portion of rivals’ market shares and profits
Prisoner’s dilemma?
- Shows how two rational decision-makers use strategic behaviours to maximise profits by guessing their rival’s behaviour but may end up being collectively worse off
- Final position = nash equilbrium
What does that nash equilibrium show?
- Conflict between pursuit of self-interest and collective firm interest
- Firms could be better off by cooperating, trying to make themselves better off ends up making them and rival worse off
Open collusion in oligopoly markets?
- Cartel is a formal agreement between firms in an industry
- Key objective is to limit competition, increase monopoly power and increase profits
Examples of open collusion?
OPEC
* Each member country assigned a quota - restrictied quantity = higher price of oil = higher profits
What factors make it difficult for a cartel to be established and maintained?
- Incentive to cheat
- Cost differences between firms (different cost curves means price difficult to set)
- Number of firms (larger the number = more difficult to arrive at an agreement)
- Possibility of a price war
- Recessions
- Potential entry into the industry (needs high barriers)
- The industry lacks a dominant firm (e.g. Saudi Arabia in OPEC)
