5.5 Oligopolies Flashcards
1
Q
Oligopoly as a market structure
A
- Firms can either operate in a market which is oligopolistic, or several firms can display oligopolistic behaviour.
2
Q
Oligopoly as a behaviour
A
- Firms which display oligopolistic behaviour might be:
-interdependent,
-have stable prices
-collude
-non-price competition. - An oligopoly is a market that is dominated by a small number of firms
3
Q
What are the main characteristics of an oligopoly?
A
- High barriers to entry and exit.
- High concentration ratio
- Interdependence of firms
- Product differentiation
4
Q
What is meant by high barriers to entry and exit?
A
- High barriers to entry
make the market less competitive.
5
Q
What is meant by a high concentration ratio?
A
- In an oligopoly, only a few firms supply the majority of the market.
- For example, in the UK the supermarket industry is an oligopoly.
- The high concentration ratio makes the market less competitive
6
Q
What is meant by the interdependence of firms?
A
- the actions of one firm
affect another firm’s behaviour.
7
Q
What is meant by product differentiation?
A
- Firms differentiate their products from other firms using branding.
- The degree of product differentiation can change how far the market is an oligopoly.
8
Q
What is the concentration ratio?
A
- is the combined market share of the top few
firms in a market.
Example:
the market share of the largest firms would be added together: 28.4% + 17.1% + 16.4% + 10.9% = 72.8%.
-The 2 firm concentration ratio is the market share of the 2 largest firms added together: 28.4% + 17.1% = 45.5%.
9
Q
What is the significance of a concentration ratio?
A
- The higher the concentration ratio, the less competitive the market, since fewer
firms are supplying the bulk of the market.
10
Q
What is a collusive oligopoly?
A
- Collusive behaviour occurs if firms agree to work together on something.
- For example, they might choose to set a price or fix the quantity of output they produce
- this minimises the competitive pressure they face.
11
Q
What is the impact of collusive behaviour?
A
- lower consumer surplus
- higher prices
- greater profits for the firms colluding.
- It can allow oligopolists to act as a monopolist and maximise their joint profits.
12
Q
What is the impact of collusive behaviour on firms in an oligopoly?
A
- have a strong incentive to collude.
- By making agreements, they can maximise their own benefits and restrict their output, to cause the market price to increase.
- This deters new entrants and is anti-competitive.
13
Q
When is collusion most likely to occur?
A
- where there are only a few firms,
- they face similar costs,
- there are high entry barriers,
- it is not easy to be caught -there is an ineffective competition policy.
Moreover, there should be consumer inertia. All of these factors make the market stable
14
Q
When does non-collusive behaviour occur?
A
- when the firms are competing.
- This establishes a competitive oligopoly.
- more likely to occur where there are:
-several firms,
-one firm has a significant cost advantage,
-products are homogeneous
-the market is saturated. - Firms grow by taking market share from rivals.
15
Q
What are the two types of collusion?
A
- Overt
- Tactic
16
Q
What is overt collusion?
A
- when a formal agreement is made between firms.
- It works best when there are only a few dominant firms, so one does not refuse.
- It is illegal in the EU, US and several other countries.
- For example, it is often suspected that fuel companies partake in overt collusion.
- This could be in the form of price fixing, which:
-maximises their joint profits,
-cuts the cost of competition, such as by preventing firms using wasteful advertising,
-reduces uncertainty.
17
Q
What is tactic collusion?
A
- occurs when there is no formal agreement, but collusion is implied.
- For example, in the UK supermarket industry, firms are competing in a price war.
- Price wars are harmful to supermarkets and their suppliers
18
Q
What is cooperation?
A
- might refer to how a firm is organised and how production is managed
- is allowed in the market, whilst collusion is not.
- Collusion is usually with poor intentions, whilst cooperation will be beneficial.
19
Q
What is collusion?
A
- Collusion generally refers to market variables, such as quantity produced, price per unit and marketing expenditure
- it is not allowed in the market
- Collusion is usually with poor intentions
20
Q
Draw the kinked demand curve
Explain what this curve depicts
A
- it illustrates the feature of price stability in an oligopoly.
- It assumes other firms have an asymmetric reaction to a price change by another firm.
- It is an illustration of interdependence between firms.
- The first part of the diagram shows a relatively price elastic demand curve.
- The second part shows a relatively inelastic demand curve.
- When firms deviate from the rigid, equilibrium price and quantity, they enter the different demand elasticities.
21
Q
What is a cartel and what is its operation/impact?
A
- 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.
- Cartels can lead to higher prices for consumers and restricted outputs.
- Some cartels might involve dividing the market up, so firms agree not to compete in each other’s markets.
22
Q
When does price leadership occur and what is the reason for price leadership?
e.g. petroleum industry, airline industry
A
- occurs when one firm changes their prices, and other firms follow.
- This firm is usually the dominant firm in the market.
- Other firms are often forced into changing their prices too, otherwise they risk losing their market share.
- This explains why there is price stability in an oligopoly; other firms risk losing market share if they do not follow the price change.
- The price leader is often the one judge to have the best knowledge of prevailing market conditions.
23
Q
What is a price war and what is the reason for price wars?
Asda, morrisons, tescos
A
- a type of price competition, which involves firms constantly cutting their prices below that of its competitors.
- Their competitors then lower their prices to match.
- Further price cuts by one firm will lead to more and more firms cutting their prices.
- An example of this is the UK supermarket industry
24
Q
What is non price competition and the reason for this?
A
- aims to increase the loyalty to a brand, which makes demand for a good more price inelastic.
- For example, firms might improve the quality of their customer service, such as
having more special offers, such as buy one get one free, free gifts, might be used to attract consumers and increase demand. - Advertising and marketing might be used to make their brand more known and
influence consumer preferences.
25
What is the impact of non price competition?
- However, it is difficult to know what the effect of increased advertising spending will be.
- For some firms, it might be ineffective.
- This would make them incur large sunk costs, which are unrecoverable.
- Brands are used to differentiate between products.
- If firms can increase brand loyalty, demand becomes more price inelastic.
- Increasing brand loyalty means firms can attract and keep customers, which can increase their market share.
26
What is the reason for barriers to entry?
- Firms might try to drive competitors out of the industry in order to increase their own market share.
- Barriers to entry are designed to prevent new firms entering the market profitably.
- This increases producer surplus.
27
The significance of interdependence and uncertainty in oligopoly: What is game theory?
- Game theory is related to the concept of interdependence between firms in an
oligopoly
- It is used to predict the outcome of a decision made by one firm, when it
has incomplete information about the other firm.
28
How can game theory be explained?
- using the Prisoner’s Dilemma, which is a model based around two prisoners, who have the choice to either confess or deny a crime.
- The consequences of the choice depend on what the other prisoner chooses.
29
How does the prisoners dilemma explain the game theory and uncertainty?
- The two prisoners are not allowed to communicate, but they can consider what the other prisoner is likely to choose.
- This relates to the characteristic of uncertainty in an oligopoly.
30
What is the dominant strategy?
- the option which is best, regardless of what the other person chooses.
- This is for both prisoners to confess, since this gives the minimum number of years that they have to spend in prison.
- It is the most likely outcome.
- This is still higher than if both prisoners deny the crime
- If collusion is allowed in this dilemma, then both prisoners would deny.
- This is the Nash equilibrium
31
What is the nash equilibrium?
- a concept in game theory which describes the strongest strategy for all players, whilst taking into account what opponents have chosen.
- They cannot improve their position given the choice of the other.
- However, even if both prisoners agree to deny, each one has an incentive to cheat and therefore confess, since this could reduce their potential sentence from 2 years to 1 year.
- This makes the Nash equilibrium unstable.
- It essentially sums up the interdependence between firms when making decisions in an oligopoly.
32
What are the advantages of an oligopoly?
- Oligopolies can earn significant supernormal profits, so they might invest
more in research and development.
-This can yield positive externalities, and make them more dynamically efficient in the long run-there could be more invention and innovation as a result
- Moreover, firms are more likely to innovate if they can protect their ideas-more likely to happen in a market where there are high barriers to entry
- Higher profits could be a source of government revenue.
- Industry standards could improve-true in the pharmaceutical industry and for car safety technology.
-because firms can collaborate on technology and improve it.
-saves on duplicate research and development.
- Since oligopolies are large, they can exploit economies of scale, so they have
lower average costs of production (shown by the LRAC curve)
33
What are the disadvantages of an oligopoly?
- The basic model of oligopoly suggests that higher prices and profits and
inefficiency may result in a misallocation of resources compared to the outcome
in a competitive market.
- If firms collude, there is a loss of consumer welfare, since prices are raised
and output is reduced.
- Collusion could reinforce the monopoly power of existing firms and makes it
hard for new firms to enter.
- The absence of competition means efficiency falls-this increases the average cost of production
