4.4 Oligopoly

Question 1

What are the characteristics of an oligopoly

Answer 1

High barriers to entry and exit

High concentration ratio

Interdependence of firms

Product differentiation

Question 2

What is meant by a cartel

Answer 2

This is a group of two or more firms which have agreed to control prices, limit output, or prevent the entrance of new firms into the market

Question 3

What is meant by price leadership

Answer 3

This occurs when one firm changes their prices and other firms follow. This firm is often the dominant firm in the market

Question 4

What is meant by price wars

Answer 4

A price war is a type of price competition which involves firms constantly cutting their prices below that of its competitors meaning competitors lower prices to match

Question 5

What is meant by non-price competition

Answer 5

This aims to increase the loyalty to a brand which makes demand for a good more price inelastic

Question 6

What is meant by barriers to entry

Answer 6

Firms might try to drive competitors out of the industry in order to increase market share. Barriers to entry prevent new firms entering the market profitably

Question 7

What does the kinked demand curve look like

Answer 7

Question 8

Explain the kinked demand curve

Answer 8

It illustrates the feature of price stability in an oligopoly showing the interdependence between firms

If price increases firms don’t react so the firm which increases loses market share

If firms decrease price the firm gains a small proportion of market share

The first part of the curve shows price elastic demand curve and the second part shows relatively inelastic demand curve

Question 9

What is meant by collusive behaviour

Answer 9

This occurs if firms agree to work together on something such as set price

Question 10

What does collusion lead to

Answer 10

A lower consumer surplus, higher prices and greater profits for the firms colluding. Allows firms to maximise their joint profits

Question 11

Why do firms in an oligopoly have a strong incentive to collude

Answer 11

They can maximise their own benefits and restrict their output to cause market prices to increase which deters new entrants

Question 12

What is meant by non-collusive behaviour

Answer 12

This occurs when the firms are competing. This establishes a competitive oligopoly

More likely to occur when there’s several firms as one firm has a significant cost advantage

Firms grow by taking market share from rivals

Question 13

What is meant by overt collusion

Answer 13

This is when a formal agreement is made between firms

Question 14

What is meant by tacit collusion

Answer 14

This is when there is no formal agreement but collusion is implied

Question 15

What is the difference between cooperation and collusion

Answer 15

Cooperation is allowed whereas collusion is not

Collusion is usually with poor intentions whilst cooperation can be beneficial

Question 16

What is meant by the concentration ratio of a market

Answer 16

This is the combined market share of the top few firms in a market

Question 17

Advantages of oligopoly

Answer 17

They can earn significant supernormal profits so might invest more in R&D which can yield positive externalities

Higher profits could be a source of government revenue

Industry standards could improve if firms collaborate and improve

Easy to exploit economies of scale meaning lower costs of production

Question 18

Disadvantages of an oligopoly

Answer 18

The model suggests higher prices and profits and inefficiency may result in a misallocation of resources

Loss of consumer welfare since prices are raised and output reduced

Absence of competition means efficiency falls which increases average costs of production