3.4.4: Oligopoly Flashcards
What is an oligopoly?
A state of limited competition where there are a few firms that dominate the market share.
What are the characteristics of an oligopoly?
-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.
What is the n-firm concentration ratio?
Total Sales Of N Firms / Total Sales Of Market X 100
What is collusion/collusive behaviour?
When firms make collective agreements to avoid competition (e.g. price competition).
Why would firms engage in collusion/collusive behaviour?
-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.
Why would firms avoid collusion/collusive behaviour?
-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.
At what conditions does collusion work best in?
-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.
What is overt collusion?
When a formal agreement is made between firms.
What is tacit collusion?
When firms coordinate without an explicit agreement.
What is a cartel?
A group of two or more firms which have agreed to control prices or prevent new firms from entering the market.
What is price leadership?
When a dominant firm changes their prices, and other firms follow.
What are advantages of collusion?
-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.
What are disadvantages of collusion?
-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.
What is an example of (overt) collusion?
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.
How does game theory link with oligopolies?
Game theory refers to the interdependence of firms, predicting the outcome of a firm when they have incomplete information about another identical firm.
Example of game theory:
Prisoners.
What is nash equilibrium?
The optimal outcome for a firm based on the expected decision of the other firm.
What is dominant strategy?
The option that has the best outcome, regardless of the other firm’s decision.
What conclusions can occur from game theory?
-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).
What are the three types of price competition?
-Price wars.
-Predatory pricing.
-Limit pricing.
Features of price wars:
-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.
Features of predatory pricing:
-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.
Features of limit pricing:
-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.
Example of price wars:
Supermarkets.
Example of predatory pricing:
Amazon.com with Diapers.com.
What are the types of non-price competition?
-Advertising.
-Loyalty cards.
-Branding.
-Quality & customer service.
-R&D.
(Oligopoly) In the long term, are firms:
-Allocatively efficient?
-Productively efficient?
-Dynamically efficient?
-No.
-No.
-Yes: firms make supernormal profits, so they can invest, and have incentives to do so due to competition.
