5.7 Oligopoly Flashcards
what are the features in an oligopoly market structure?
few firms dominate the market (high concentration ratio)
differentiated goods
firms are price makers
high barriers to entry/exit
Interdependence (firms rely on one another)
Price rigidity (stable)
Non price competition (high expenditure on marketing costs, quality competition, brand imaging etc.)
Profit maximisation not sole objective due to interdependence (we don’t know objective could be sales, rev who knows)
examples of oligopolies
UK= supermarket industry, industry, bus, airline markets
Worldwide= soft drink companies (Pepsi and coke)
what diagram can be used to illustrate oligopoly?
kinked demand curve
how does kinked demand curve show interdependence
if oligopoly firm raises price proportionally they lose a lot of market share as quantity decreases
If oligopoly firm decreases price proportionality in the long term they don’t gain enough market share for it to be worth while as other firms will follow.
therefore price rigidity
how does kinked demand curve show why firms don’t need to change their price?
When adding the marginal revenue curve to the kinked demand curve model we see if costs increase i.e Marginal cost curve shifts outwards within the vertical part of the Mr curve. if oligopolistic is profit maximiser (mr=mc) in any case they will end up charging at P1 due to reading off the AR curve at the same position due to the marginal revenue point being vertical assuming quantity has stayed the same.
(Draw if don’t understand)
Conclusions from the kinked demand curve?
could be price competition (even if doesn’t make sense e.g. price wars for supermarkets)
see a lot of non price competition (branding, adverting)
interdependence could frustrated and tempt firms to collude and act as a monopoly
what is concentration ratio
the collective market share of the biggest firms in the market
what other diagram apart from kinked demand curve show something about oligopoly
game theory
what does game theory show
why oligopolies rely on interdependence and why their is price rigidity.
explain game theory
two firms (A,B) are facing the same pricing decisions to either price high or price low
if the two firms both charge the high price they will gain an equal amount of profit
If firm B decides to charge a high price firm A has a decision to make as if they match the high price they will both make the same profit, however if Firm A chooses a rational outcome of charging a lower price they could make more profit at the expense of firm B making less profit.
if firm A decides to charge a lower price and firm B matches this they will both make a smaller profit then if they both decided to charge a higher price and if Firm B charges the higher price firm A will make a higher profit
the box with the two smaller equal outcomes ( if firm A and B both charge the lower price) is the Nash equilibrium this is a rational equilibrium which will last in the long term
The dominant strategy in the game is to charge the lower price as each firm can either make more profit than the other or match the same profit.
what are the conclusions from game theory
price rigidity as dominant strategy in this case is to charge the lower price therefore non price competition is needed to gain market share and edge on competitors
this temps collusion, both firms can maximise profits by agreeing to both charge high price rather settling for the nash equilibrium
but also temptation to cheat on agreement both firms may agree on a price but a firm can undercut to make more profit and cheat the collusion this is especially apparent if one firm is worse of from another
what are the two types of oligopolies
competitive and collusive
what are competitive oligopolies based off and what factors promote competitive oligopolies .
based upon price or non price competition (branding)
if their is a large number of firms compared to standard oligopoly organising collusion is a too tricky and wont be done
low barriers to entry making huge supernormal profit by colluding isn’t incentive as more firms will enter
one firm with significant cost advantages, difficult to do
homogenous goods, don’t have price making power to fix prices
saturated market if a lot of price wars and competition and if is the only way to gain advantage not going to see collusion
what are the two types collusive oligopoly
overt collusion (firms get together to fix prices and quantities)
tacit collusion e.g. price leadership by a dominant firm which smaller firms follow or agreeing to engage in price war.
what factors promote collusive oligopoly?
small no of firms easier to organise
similar costs easer to organise and fix prices and quantities
high entry barriers supernormal profit is protected and wont attract new entry so benefits of collusion could be long term
ineffective competition policy easy to get away with
if consumer loyalty to other firms or consumer inertia (laziness) cheating is not going to benefit you as not guaranteed.
