LS13 : Oligopoly

Question 1

what is the purpose of concentration ratio?

Answer 1

to gauge how close a particular market is to being a monopoly

Question 2

how can concentration ratio be calculated?

Answer 2

• measure of market share of largest firms in an industry (shares in output)
• proportion of workers in any industry that are employed in the largest firms (shares in employment)

Question 3

what are the key characteristics of an oligopoly?

Answer 3

• small number of large firms
• high barriers to entry
• both homogenous or differentiated
• mutual interdependence

Question 4

explain the small number of large firms characteristic in an oligopoly.

Answer 4

dominated by small number of large firms, though this can vary from industry to industry

Question 5

explain the high barriers to entry characteristic in an oligopoly.

Answer 5

difficult for new firms to join on a small scale due to very high costs. legal barriers such as patents. control of natural resources by other firms. aggressive tactics such as advertising or threat of takeover.
high start up costs with developing new products and advertising

Question 6

explain the mutual interdependence characteristic in an oligopoly.

Answer 6

small number of firms means that decisions taken by one firm affects the others. if one firm changes its behaviour, this can affect the other firms demand curves

Question 7

what is strategic behaviour in an oligopoly?

Answer 7

based on plans of action that take into account rivals possible courses of action. actions are based on the expected actions and reactions of their rivals. strategic behaviour is a result of interdependence.

Question 8

what does incentive to collude mean?

Answer 8

collusion refers to an agreement between firms to limit competition by fixing price or lowering output. by colluding, this reduces uncertainties and maximises profits for the industry.

Question 9

what does incentive to compete mean?

Answer 9

each firms faces an incentive to compete in order to capture a portion of rival market share and profit

Question 10

what is game theory?

Answer 10

theory which illustrates mutual interdependence, strategic behaviour and conflicting incentives. mathematical technique analysing the behaviour of decision makers who are dependent on each other, and who use strategic behaviour to anticipate the behaviour of their rivals.

Question 11

explain game theory.

Answer 11

illustrates the prisoners dilemma, showing how two rational decision makers, who use strategic behaviour to maximise profits by trying to guess the rivals behaviour, which may result in being collectively worse off. final position that results from this is nash equilibrium.

Question 12

what is the prisoners dilemma?

Answer 12

two players act selfishly resulting in a sub-optimal position for both. just by co-operating is not always in ones best interest, so may decide to cheat

Question 13

what is nash equilibrium?

Answer 13

where each player has nothing to gain by changing strategy, given the choices of the other player

Question 14

what is a price war?

Answer 14

since rivals are likely to match price cuts, all firms end up with lower prices and lower profits

Question 15

why do firms avoid price wars?

Answer 15

realise that everyone will become worse off through price-cutting. creates a strong incentive for them to compete on the basis of factors other than price

Question 16

what is a collusion?

Answer 16

refers to an agreement between firms to limit competition, increase monopoly power and increase profits. usually involves price-fixing agreements

Question 17

what is an example of formal collusion?

Answer 17

cartels

Question 18

what is an example of informal collusion?

Answer 18

price leadership

Question 19

what is a cartel?

Answer 19

a formal agreement between firms in an industry to limit competition in order to increase profits

Question 20

how do firms in a cartel limit competition?

Answer 20

• limiting quantity which increases price
• fixing the price at which output can be sold
• setting restrictions on non-price competition
• dividing the market geographically
• agreeing to set up barriers to entry

Question 21

give an example of a cartel.

Answer 21

OPEC (organisation of the petroleum exporting countries)

Question 22

give seven factors which make it difficult for a cartel to be established and maintained.

Answer 22

• incentive to cheat
• cost differences between firms
• number of firms
• possibility of a price war
• recessions
• potential entry into the industry
• industry lacks a dominant firm

Question 23

what is informal / tacit collusion?

Answer 23

refers to co-operation that is implicit or understood between co-operating firms without a formal agreement. this method attempts to bypass the obstacles of formal collusions.

Question 24

what is price leadership?

Answer 24

type of informal collusion where a dominant firm in the industry sets a price and also initiates any price changes. the remaining firms become price takers, accepting the price established

Question 25

give five factors which make it hard to sustain price leadership.

Answer 25

• cost differences
• incentive to cheat
• possibility of a price war
• new firms entering
• may not be legal

Question 26

how is limit pricing set?

Answer 26

set a price lower than profit maximising price (MC=MR), thus earning less than the highest possible profits, discouraging new firms from entering the industry

Question 27

why are high barriers to entry and exit essential for price leadership to be effective in the long run?

Answer 27

it deters new entrants from entering the market and it insulates the price leader from competition