3.5.7 - Oligopoly Flashcards
What is an oligopoly?
A market with a few firms.
Where does the word oligopoly come from?
Greek word ‘oligos’ meaning few.
Where does the problem arise with the definition of oligopolies?
The definition of ‘few’ is in the eye of the beholder. Is 10 firms an oligopoly? But why is 11 not?
What is a concentration ratio?
Measures the market share of the biggest firms in the market.
A five-firm concentration ratio means that it tests the concentration of the biggest 5 firms.
What is an instance of the competition in the UK supermarket industry?
Tesco attempting to compete with Aldi and Lidl.
Why do some argue that Tesco cannot compete with Lidl and Aldi?
Some claim that Tesco should slash prices to match Aldi and Lidl, but Aldi has publicly stated they would always be more than 15% cheaper than Tesco.
Aldi stocked only 1500 lines compared to Tesco’s 60000.
Aldi stocks 90% of their lines with own-brand products.
Aldi delivers products in shelf-ready packaging.
Tesco would struggle incredibly to compete with a firm that is designed to be as cheap as possible.
What is market conduct?
The pricing and marketing policies pursued by firms.
Also known as market behaviour.
How can an oligopoly be defined?
The market structure.
The number of firms in the market.
Market conduct.
How do rivals affect oligopolistic firms?
Oligopolistic firms affect their rivals by their decisions.
Rivals affect other oligopolistic firms with their decisions.
When does competitive oligopoly exist?
When rival firms are interdependent in that they must take into account the reactions of other firms.
Firms are independent in that they make these decisions by themselves.
What are the characteristics of oligopolies?
1 – High Barriers To Entry
#2 – Price Making Power
#3 – Interdependence Of Firms
#4 – Differentiated Products
#5 – Non-Price Competition
Why is uncertainty a feature of competitive oligopolies?
A firm cannot ever be sure if a change in their firm will have positive or negative effects.
If a firm increases their prices, will other firms follow or will they hold prices in an effort to gain extra sales?
What is a competitive oligopoly known as?
Non-collusive oligopoly.
What is an uncompetitive oligopoly known as?
Collusive oligopoly.
What is a cartel?
A collusive agreement of firms (usually) to fix prices, limit output or deter entry of new firms.
What is an example of a cartel in the real world?
OPECs forming a cartel to limit oil exports to other countries.
How can firms remove the uncertainty from oligopolies?
Collude together to form a collusive oligopoly.
What do cartel agreements allow?
Inefficient firms to stay in business and efficient firms to enjoy supernormal profits.
What do disadvantages do cartels display?
Disadvantages of monopolies (high prices, restriction of choice) without benefits of monopolies. (economies of scale, dynamic efficiency)
Explain the graph.
In collusive oligopolies, firms can choose to act as a single monopolist. In this example, one firm generates 250 products and there are 750 products in the market. This means there are 3 firms in the collusive oligopoly.
The right hand side MC curve is the sum of the identical 3 MC curves on the left. Each firm individually charges £10, outputting 750 total products. The 750 produced is below the 1000 in perfectly competitive markets (where MC=AR).
The members of the cartel split the profits from the 750 outputs equally, each producing 250 units.
What is the problem with each individual firm in the cartel?
Each firm wants to maximise their profits.
There is an incentive for the firm to cheat on the cartel.
The marginal cost of producing one more unit is £4 but the marginal profit is £10.
One member of the cartel can increase profit by producing more than 250 units and selling them below £10.
The collective interest should be to maintain the cartel, but the individual interest is to take advantage of both.
What is the kinked demand curve model?
A model that demonstrates how a competitive oligopolist will be affected by rivals’ decisions and reactions to their price and output changes.
As imperfectly competitive markets lack accurate information, the D = AR curve is not necessarily accurate, representing the firm’s estimate of how demand changes when the firm changes the price.
Draw the kinked demand curve.
Explain the kinked demand curve.
Say a firm currently produces at Q1 and at P1. If a firm raises their price to P2, they do not expect other oligopolistic firms to increase their price as other firms will try to increase market share. The rise in price from P1 to P2 will have a larger fall in demand from Q1 to Q2. This means that for price rises, the demand becomes more elastic.
If a firm reduces their price to P3, they expect other firms to reduce their price so as to not lose market share and sales. This means demand will not fall as rapidly, from Q1 to Q3. This means that for price reductions, demand becomes more inelastic.
In both situations, raising or lowering prices likely reduces total profit, meaning most oligopolistic firms will leave the price unchanged.
How can you develop the kinked demand curve theory?
Explain this graph.
Using the MC curves, we can explain why prices are more stable in oligopoly.
Essentially, there are two graphs here, with a discontinuity at the kink where the curves intersect.
The MC curves can rise or fall within the discontinuity and still maximise profits as MC = MR at all points from B to C.
It therefore stands to reason that firms will not change their prices as they will no longer maximise profits if prices are lowered or increased.
