HL - Theory Of The Firm: Oligopoly Flashcards
What are the assumptions of this model?
Small number of large firms
Interdependence is a common feature - price change of one firm affects the others
Products may be differentiated (e.g washing powder which are all owned by P&G) or homogenous (e.g the energy market)
High barriers to entry
Large economies of scale
What’s the interdependence?
Its responsible for collusion.
Usually behave strategically:
Although there’s the incentive to compete for higher profits, colluding reduces uncertainty, as they can agree on level of output to raise prices.
What are concentration ratios and how do you find them?
The percentage of the total market output accounted for by the largest “n” firms.
Divide total profits by the sum of the “n” amount of firms profit and items by 100.
What does the concentration ratio indicate?
The higher the concentration ratio, the less competitive the industry. A 4 firm concentration ratio above 40% indicates an oligopolistic market.
What’s the drawback to the concentration ratio?
They don’t take into account completion globally or from substitute goods. Nor do they take into account how dominant the biggest one or two firms individually are.
A more complex index is called the Herfindahl index which overcomes this particular issue.
What is the game theory - the prisoners dilemma?
Look on handout
What’s an example collusion?
British Airways was fined £270m (their annual profit is £611m) for colluding with Virgin on long haul flights in response to rising oil prices. Tickets rose from £5-60 per ticket, and Virgin was the whistle blower and gave information to OFT and got no penalties.
What is a cartel?
A formal agreement between firms to act as a monopoly. W,g OPEC, although they are slowly losing power.
What are the problems with a cartel?
Every firm in it has the incentive to cheat.
It can be difficult to reach an agreement on output quotas and price as each firm faces different costs
Cheating on the agreement can lead to a price war, which all members will lose.
High barriers to entry to maintain economic profit.
What is tactical/ informal profit?
Unspoken/ unwritten collusion. Hard to prove its not just natural operation of markets
Normally a price leadership by a dominant firm.
Don’t all set the same price but the differentials remain constant
Limit pricing is another form of collusion - set prices low enough that other firms stop entering the market
Examples of informal collusion
Mortgage leaders and petrol retailers: suppliers follow the pricing and move them in the same direction. It can take time for price difference to emerge, which might make consumers switch their demand.
What’s the kinked demand curve?
Explains the existence of price rigidities and why oligopolistic firms do not compete with each other.
If they raised the price not many people would buy it due the elasticity. If it reduced its price, other firms would also reduce their price.
Shows the interdependence
What’s the consequence from the kinked demand curve?
Prices are sticky around the equilibrium price.
Although the model doesn’t explain how the market price is arrived at in the beginning.
The broken MR curve means costs could change within that range and not alter the profit max. Level of output.
Criticisms of oligopoly
Allocative/ productive efficiency isn’t achieved, because they don’t have to.
Higher prices but lower output under competitive conditions
Higher production costs due to lack of price competition
Benefits of oligopoly
Economies of scale can be achieved due to large size of firms
R&D can be done from large funds
Technological improvements increasing efficiency and lower prices.
