3.4.4 Oligopoly Flashcards
Characteristics of an oligopoly?
- High barriers to entry and exit
- High concentration ratio
- Interdependence of firms
- Product differentiation
What is the UK 5 firm concentration ratio for supermarkets constantly around?
The UK supermarket’s 5-firm concentration ratio is constantly around 67%
What does interdependence of firms mean in an olipoly?
- With relatively few competitors, firms study each other’s behaviour and are highly interdependent in their actions
- This interdependence generates the use of game theory
How do you calculate a concentration ratio?
If its 5 firm
Add up X (could be value of sales for instance) then work out as a total of the overall sales in the market.
What is collusive behaviour?
- Collusive behaviour in oligopolies occurs when firms cooperate to fix prices and restrict output
They cease to compete as vigorously as they can
What is non collusive behaviour?
Non collusive behaviour in oligopolies occurs when firms actively compete to maintain/increase market share
Reasons why an oligopoly can collude?
- There are few firms so it is easy for firms to colloborate.
- Firms face almost identical costs as they all have economies of scale
- They also have similar prices as lowering them would only cause other firms to drop their prices = lower profits for all
- The barriers to entry make it unlikely that new entrants will emerge and disrupt the status quo
- If there is ineffective regulation then firms are empowered to collude with little consequence
- They usually have a high degree of brand loyalty and an established market share
What is the effect of collusion on the market?
The net effect of collusion is that a group of firms end up acting like a monopoly in the market
What is overt collusion?
Overt collusion occurs when firms explicitly agree to limit competition or raise prices (price fixing)
What is a cartel?
A cartel is a partnership between two or more companies whose goal is to manipulate the market and cost of goods to their advantage
Illegal in most countries - UK
How does overt collusion happen / what do they do?
- Price fixing
- Setting output quotas which limit supply and naturally results in price increases
- Agreements to block new firms from entering the industry
- Agreements to pay suppliers the same price thereby driving down prices in the supply chain (monopsony power)
Effects / impacts of overt collusion?
- Higher prices for consumers
- Less output in the market
- Poor quality products and/or customer service
- Less investment in innovation
What is tacit collusion?
Tacit collusion occurs when firms avoid formal agreements but closely monitor each other’s behaviour usually following the lead of the largest firm in the industry
What is the most common form of tacit collusion?
The most common form of tacit collusion is price leadership or price matching
- This occurs when firms monitor the price of the largest firm in the industry and then adjust their prices to match
Tacit collusion impacts?
- It is difficult for regulators to prove that collusion has occurred
- It provides similar benefits to firms as overt collusion, but perhaps not to the same degree
- It has similar consequences for consumers as overt collusion, but perhaps not to the same degree
What is price competition in an oligopoly?
Firms in an oligopoly market engage in three types of price competition:
- Price wars
- Predatory pricing
- Limit pricing
What is limit pricing in an oligopoly?
Limit pricing - Occurs when firms set a limit on how high the price will go in the industry. A lower price reduces profit and disincentivize other firms from joining the industry. The greater the barriers to entry the higher the limit price is likely to be as firms are already disincentivized
What is predatory pricing in an oligpoly?
Predatory pricing: this is the practice of lowering prices when a new competitor joins the industry in order to drive them out. Prices are often lowered to a point below the cost of production. Once they have left the market, prices are raised again. This pricing strategy is usually illegal as it is anticompetitive.
What are price wars in an oligopoly?
Price wars: occur when competitors repeatedly lower prices to undercut each other in an attempt to gain or increase market share.
What is non price competition?
Firms engage in a wide range of non-price competition strategies, these involve product differentation, branding, marketing etc.
The aim is to increase product differentiation, develop or increase brand loyalty, and to increase market share
Some examples of non price competition?
- Loyalty cards and rewards
- Branding
- Celebrity/influencer endorsement - Dubai Chocoloate
- Corporate sponsorship e.g. New Balance X Bukayo Saka
- After sales service
- Delivery policies
- Product warranties
What is game theory?
Game theory is a mathematical framework which is used by firms to ensure optimal decisions are made in a strategic setting where there is a high level of interdependence
What is a dominant strategy in game theory?
The one that carries the least risk
What is a nash equilibrium?
A Nash Equilibrium occurs when no player (firm, person, etc.) has an incentive to change their strategy, given the strategy of the other player(s).
