4.1.3 Oligopoly

Question 1

oligopoly

Answer 1

dominated by a small number of firms

Question 2

concentration ratios

Answer 2

• gives us detail on oligopolies and the strength of their market power
• Measures the extent to which a market or industry is dominated by a few leading firms
• Calculated by adding the market shares of the biggest firms in the industry → Biggest three = three firm ratio
• Oligopoly exists when the top five firms in the market account for more than 60% of total market sales
• More competitive when lower concentration ratios → more smaller firms
• Can provide insights into the degree of market power held by largest firms
• Shows asymmetry between large/small firms and the distribution of market power

Question 3

key features of an oligopoly

Answer 3

• Product branding
• Barriers to entry are significant → EOS, vertical integration to control supply chains/distribution
• Inter-dependent decision making: firms take into account the reactions of their rivals to any change in price, output or forms of non-price competition
• Cannot take over eachother as they all have similar power → increasingly competitive market
• There can be a market leader (eg tesco)
• Non price competition: consistent feature of the competitive strategies of oligopolistic → product differentiation including branding, quality variations, and adverting to create brand loyalty
• Can cause an increase in costs → market research etc

Question 4

Competition

Answer 4

• Large firms in the market are interdependent: watch eachothers prices and there is significant competition
• Competition is either price or non price
• Eg supermarkets
• High advertising costs
• Location of stores
• Setting up small stores that compete with convenience stores
• Price wars are not ideal: all profits suffer, so there is an incentive to keep prices fairly stable and limit competition on them
• Aldi and lidl: increased market shares in UK supermarkets → less stable market

Question 5

price competition in an oligopoly

Answer 5

• Price wars: firms lower prices to gain market share which ends in reduced profits for all
• Predatory pricing: firms set low prices with the intent of driving competitors out of the market, and then it raises prices after
• Limiting prices: a strategy where a dominant firm sets prices low enough to discourage new entrants into the market

Question 6

non price competition in an oligopoly

Answer 6

• more important as interdependence reduces freedom of changing prices
• Product differentiation: firms emphasize unique qualities and features of their products through branding, quality, design or advertising
• Advertising and marketing: firms engage in extensive advertising and marketing campaigns to create brand loyalty and awareness
• Innovation: development of new products, tech or processes
• Customer service: offering exceptional customer service and support as a competitive advantage
• Distribution channels: efficient distribution networks to reach customers faster and more conveniently

Question 7

kinked demand curve

Answer 7

• If firm increase prices, other firms will keep prices stable to gain CA, and firm A loses profits (elastic)
• If fim A reduces P, other firms cut prices to keep competition, so you have the same demand for lower prices = lower revenue (inelastic)
• Oligopoly: base decisions on competition

Question 8

why is collusion beneficial

Answer 8

• Price stability
• Reduced marketing and advertising costs if firms co-operate and not compete
• Guaranteed supply from producer cartel
• Can raise prices of exports: increased investment and revenues for countries that need it (emerging countries with natural resources)
• Avoid price wars
• Can raise prices and limit competition: increasing profits collectively -> all benefit
• Overt collusion reduces risk and increases certainty

Question 9

what is overt collusion

Answer 9

firms openly agree to cooperate and set prices/output levels so cartels are created

Question 10

collusion is easy when

Answer 10

• Small number of firms in market
• Substantial barriers to entry
• Large number of customers
• Total market demand not too variable → inelastic ped
• Output can be easily monitored
• Price discounts are hard to deliver: hard to undercut rivals on pricing

Question 11

why are cartels unstable

Answer 11

• Falling demand causes excess capacity in the industry, eg economic downturn
• Non cartel firms enter the market, not under cartel agreements
• Exposure of illegal price fixing by gov/regulators
• Over-production and excess supply which breaks price fixing
• Prisoners D: collusion breaks down as firms have an incentive to cheat
• Joint profit maximisiation does not mean each firm is maximising profits on their own
• Long run, firms want larger profits → tradeoff between agreements and profit motive

Question 12

tacit agreement

Answer 12

• Understanding that develops between competing businesses
• No formal agreement but firms do not try to increase competition levels
• Set prices at similar levels and stick to non price competition
• Different to perfect competition, where all firms are price takers
• Sellers with significant market share can become a price maker → price leadership
• This rise in prices leads to others increasing prices
• A range of price strategies is chosen
• Price war can occur

Question 13

Non collusive behaviour

Answer 13

• Competition: firms may choose to compete aggressively to gain market share and increased profits individually
• Legal constraints: regulation and antitrust laws, encouraging individual competition
• Different objectives: firms have different goals and incentives making collusion difficult

Question 14

prisoners dilemma and Game theory

Answer 14

• 2 rational firms
• Aggressive competition, they may trigger a price war and both suffer low profits
• If both firms collude and set high prices, they wil both have high profits
• Each firm has an incentive to betray and gain higher profits, but if both firms do this they both suffer
• Not best outcome for consumers