Concentrated markets: the theory of oligopoly Flashcards
What is an oligopoly?
Where a few large firms have the majority of the market share
What is a concentration ratio?
The proportion of the market held by the dominant firms
What does a concentration ratio of 5:80 mean?
The 5 largest firms possess 80% of the market share
What are the barriers to entry? (7) (PAMINBR)
Predatory pricing Advertising Multiplicity of brands Integration Non-price competition Branding Research and development
How does predatory pricing act as a barrier to entry?
Large firms can lower there prices where other small firms are unable to compete
What is predatory pricing?
Setting a price that may bankrupt a competitor firm in order to try and take it over
How does advertising act as a barrier to entry?
Large firms can spread the fixed costs of advertising over a large volumes of units, which decreases the unit costs
Small firms have to match the level of advertising, but with a smaller volume of output, their unit cost will be higher
How does multiplicity of brands act as a barrier to entry?
By aiming at every area in the market, the firm is likely to gain customers who change brands frequently
How does integration act as a barrier to entry?
Large firms are able to control the supply of resources, can lead to predatory pricing
What is integration?
Combining with other firms
How does non-price competition act as a barrier to entry?
Loyalty cards, persuades consumers to continue shopping with the same firm
How does branding act as a barrier to entry?
Firms stress that their brands have unique characteristics, a brand image is created through advertising, making the demand more inelastic
How does research and development act as a barrier to entry?
Can improve the quality of their products
What does interdependent mean?
Where actions by one firm will have an effect on the sales and revenue of other large firms in the market
What is a price war?
Where firms competitively lower prices to increase their market share
What is reactive behaviour?
The action taken by firms in response to a change in behaviour of a competitor
What is brand loyalty?
A measure indicating the degree to which consumers will purchase a firm’s product rather than a competing firm’s product
In the kinked demand curve, above the price, why is the demand curve elastic?
If a firm raises its price, competitors will not change theirs, and the firm will experience a fall in total revenue
In the kinked demand curve, below the price, why is demand curve inelastic?
If a firm lowers its price, competitors will follow, and the firm will experience a fall in total revenue
In the kinked demand curve, if the MC curve fluctuates withing the discontinuity, what happens?
There is no change in the level of output or price
In the discontinuity section of the kinked demand curve, if the MC curve shifts upwards, what happens?
The oligopolist would absorb all of the cost increase by taking a cut in profit
In the discontinuity section of the kinked demand curve, if the MC curve shifts downwards, what happens?
The oligopolist profit levels would increase
What are the problems with the kinked demand curve theory? (2)
There is no explanation of how the original price was determined
Ignores non-price competition
What is non-price competition likely to increase?
Increases costs (e.g-advertising) However avoids price wars
What is game theory?
An analysis of how game players react to changing circumstances and plan their response
What is zero sum game?
Where a gain by one player is matched by a loss by another player
What is risk averse?
Where one party does not take any action that might promote retaliatory activity by another party
What us collusion?
Where firms cooperate in their pricing and output policies
What is the Prisoners’ dilemma?
Where prisoners both choose the worst option
What is Nash equilibrium?
Where the optimum strategy is to maintain current behaviour
What is formal collusion?
Some form of agreement exists between the key firms in the industry about price and output policies
What is a restrictive agreement?
Where firms collude to indulge in anti-competitive policy
What are joint profits?
Where firms agree to maximise shared rather than their individual profits
What is the aim of restrictive agreements?
To increase the level of shared profits at the consumers’ expense in terms of price, quality or availability
What is a cartel?
A group of firms working together, or colluding
What are the condition necessary fir a cartel to operate successfully? (3)
Homogeneous products
High entry barriers
The market being supplied should be isolated from supplies by producers outside the cartel
What are the outcomes of a cartel, for producers? (3)
Increase in sales revenue and profit
There will be an increase in non-price competition
Increases in R&D
What are the outcomes of a cartel for consumers? (2)
Increase in the price of a product
Reduction of the consumer surplus
What is informal collusion?
May operate by one firm acting as a price leader
What is a price leader?
A firm that establishes the market price that all other firms in the agreement follow
What is barometric price leadership?
A firm whose price changes are accepted as they are adroit at interpreting market conditions
What is parallel pricing?
Where firms charge identical prices
What is tactic collusion?
Where firms have reached an agreement as to each others behaviour as a result of repeated observations over time
What is transfer pricing?
Where multinationals can alter costs and prices to benefit from different levels of tax in different countries
What is cost plus pricing?
Where are firm calculates the average cost an adds a mark up and makes this the selling price
What are menu costs?
The time and money spent by businesses in changing their prices in line with inflation
