4. Market Structures - Oligopoly Flashcards
What are the necessary conditions for an oligopoly?
- Few dominant firms2. High barriers to entry/exit3. Product differentiation4. Interdependence (price rigidity)5. Non-price competition6. Firms profit max. & aim to increase market shares
What are the two potential explanations for price rigidity in an oligopoly market?
Kinked demand curve theoryGame theory
How does the kinked demand curve theory explain price rigidity?
It says the demand curve is kinked around a certain price and quantity of a good/service - v elastic above and v inelastic below - this is bc if firms increase price - rivals don’t follow, firm loses market share - if firms decrease price everyone follows - price war - everyone ends up with same market share but lower prices - therefore makes sense not to change or compete on price
How is price rigidity shown on a kinked demand curve diagram?
The kinked demand curve is just two halves of an elastic and inelastic demand curve stuck together - MR = twice as steep - but directly below the kink in AR the MR curve has a vertical section before returning to its twice as steep gradient - this vertical section shows price rigidity bc costs can change but prices won’t
How does game theory work?
Game theory uses the idea of interdependence - it says that firms will make decisions based on the likely responses of rivals and adjust decisions accordingly
Illustrate Game Theory with an example.
Firm A & B are selling good X. Both can either price at £1 or 90p. Initially, both price at £1 and earn £2m each. Each firm thinks in the following way; if my rival maintains prices of £1 reducing my price to 90p will win me some market share and increase my earning to £2.2m, if my rival decreases prices to 90p I will lose market share and only make £1m so I will also need to reduce prices to 90p. This thinking from both firms leads to both firms reducing prices to 90p - they have the same market share as before but now prices are lower - everyone loses out - for this reason oligopolists are reluctant to engage in price wars bc everyone loses
What may oligopoly firms do to avoid price wars?
They may collude - an activity in which they agree to fix prices at certain levels - this creates collusive oligopolies otherwise known as Cartels
What are the two types of collusion?
Tacit Collusion - legal - price leadership - firms follow the pricing strategies of the dominant firm in the industry without explicit agreementsFormal, explicit collusion - illegal - formal, explicit agreements to price fix
What factors encourage the formation of a competitive oligopoly?
- Many firms - harder to organise collusion2. Easy market entry - SNPs from collusion competed away anyway3. Homogenous goods - no ability to price make4. Saturated Market5. 1 firm with cost advantages - ‘ideal’ fixed price lvl unlikely to be consistent for all firms
What factors encourage the formation of a collusive oligopoly (cartel)?
- Small no. of firms2. Similar costs3. High entry barriers 4. Ineffective competition policy 5. Consumer loyalty and consumer inertia - if these exist decreasing prices is not guaranteed to increase market shares so people collude
Is a competitive oligopoly alloc., prod., dyn., efficient?
THE SAME AS A PERFECTLY COMPETITIVE MARKETAllocativley Efficient - yesProductively Efficient - yesDynamically Efficient - not reallyX-efficiency - yes(- no economies of scale)
Is a collusive oligopoly alloc., prod., dyn., efficient?
THE SAME AS A MONOPOLY MARKETAllocativley Efficient - noProductively Efficient - noX-efficieny - noDynamically efficient - yes(it may have some economies of scale but less than monopolies bc there are several firms)
