LS13 : Oligopoly Flashcards
what is the purpose of concentration ratio?
to gauge how close a particular market is to being a monopoly
how can concentration ratio be calculated?
- 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)
what are the key characteristics of an oligopoly?
- small number of large firms
- high barriers to entry
- both homogenous or differentiated
- mutual interdependence
explain the small number of large firms characteristic in an oligopoly.
dominated by small number of large firms, though this can vary from industry to industry
explain the high barriers to entry characteristic in an oligopoly.
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
explain the mutual interdependence characteristic in an oligopoly.
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
what is strategic behaviour in an oligopoly?
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.
what does incentive to collude mean?
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.
what does incentive to compete mean?
each firms faces an incentive to compete in order to capture a portion of rival market share and profit
what is game theory?
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.
explain game theory.
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.
what is the prisoners dilemma?
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
what is nash equilibrium?
where each player has nothing to gain by changing strategy, given the choices of the other player
what is a price war?
since rivals are likely to match price cuts, all firms end up with lower prices and lower profits
why do firms avoid price wars?
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
what is a collusion?
refers to an agreement between firms to limit competition, increase monopoly power and increase profits. usually involves price-fixing agreements
what is an example of formal collusion?
cartels
what is an example of informal collusion?
price leadership
what is a cartel?
a formal agreement between firms in an industry to limit competition in order to increase profits
how do firms in a cartel limit competition?
- 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
give an example of a cartel.
OPEC (organisation of the petroleum exporting countries)
give seven factors which make it difficult for a cartel to be established and maintained.
- 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
what is informal / tacit collusion?
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.
what is price leadership?
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
give five factors which make it hard to sustain price leadership.
- cost differences
- incentive to cheat
- possibility of a price war
- new firms entering
- may not be legal
how is limit pricing set?
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
why are high barriers to entry and exit essential for price leadership to be effective in the long run?
it deters new entrants from entering the market and it insulates the price leader from competition
