Market structure and Oligopoly Flashcards
Market structures
The structure of a market depends on the number of firms and their ability to enter and exit markets freely.
Lower barriers to entry makes a market more contestable.
Main features of a Oligopoly
- The market is dominated by a few, large, dominant firms.
- A small number of large firms that dominate the market
- High barriers to entry, this because there is likely to be signifcant brand loyality in the market and preixisting firms experience signifcant economies of scale. Predatory pricing and limit pricing strategies may deter new entrants
- There is mutual interdependence between firms, actions of one firms affects the action of another.
- High concentration ratio, only a few firms supply the majotiy of the market.
- Product differentiation, firms differentiate their products from other firms using branding, They compete on non-price comeptition, advertising and quality.
There are two ways in which oligoplies can operate
- They can compett with one another, either through pricing stregies or via non-price competition. (NON Collusive beahviour)
- They can co-operate with one and another, colluding on strategies (price fixing and other collusive beahavious.
Price rigidity in a Oligopoly
This is one of the possible outcomes of a Oligopoly, and we can explain this through a kinked demand curve.
- If firms were to increase their price other firms may not follow suit, resulting in a large subsitution effect, away from this firm towards its competitors, reduceing total revenue and profits.
-If firms were to lower their prices other firms would follow suit and demand is inelastic for price decreases as other firms would also lower prices and demand would not have a signifcant rise, they would therefore lose revenue and therefore profit.
Due to their INTERDEPENDENCY on other firms it isnt in their interest to adjust prices.
Price strategies
- This is another possible outcome of a oligoploy, while price rigidity is possible there is also a number of pricing strategies that firms could adopt.
Predatory pricing
Limit pricing
Price wars
Predatory pricing
Occurs when an established firm in the market is threatend by new entrants and they delibrately drive competitors out of the market by setting very low prices or even sometimes selling below AVC.
- Revenue falls and loses are possible but are not a issue due to hisotrical profits and ability to borrow.
WHY wouldnt they do this?
Ilegeal in the UK as it is anticompeitive and bad for the consumers in the long run, the CMA heavily regulates the market
Limit pricing
Limit pricing is pricing by a incumbent firm to deter entry or the expansion of smaller firms. The limit price is below the short run profit max price, but above the competiive level and will not result in losses. Short run depatruee from profit max as a result.
WHY wouldnt they do this?
Ilegeal in the UK as it is anticompeitive and bad for the consumers in the long run, the CMA heavily regulates the market
Price wars
When goods are weakly branded firms may fight for market share through agressive pricing strategies, slashing prices to undercut their rivals, firms might make short-run losses to gain customers
Ultra competiive pricing beahviour
This could happen when there are homogenous products, difficulty branding, and many firms.
Lower barriers to entry
Non-price strategy
Product
Price
Place
Promotion
Product non price strategies
- INVESTMENT into prodcuts
- Product quality
- Diversify product
- Visuals/appealing e.g apple
- Range
- Design, materials used and asthetic
Place non-price strategies
- Moving to more competitive locations
- London, Oxford street,
- Moving to online
Promotion non-price strategies
Advertisments
- Buy one and get one free
- Billboards, posters, digital, standard of living and branding
- Informative advertisement
- Pursuasive advertisement
How do firms collude?
- Firms agree to limit competiton between themselves, increasing monoploy power and boosting profits.
- This can include a agreement to raise prices and fix them, acting as one firm, this is called price fixing
- Raising prices by a fixed amount each year
- Agreeing not to compete with each other in certain geographical areas and on certain products.
- It can be a formal agreement or something more informal (price leadership, raising firms in order to attract other firms to raise prices)
Why would firms collude
- Remove competitve pressures
- Raises prices and therefore revenue
- Increase profits
- Create local monopolies, they can act as a monoploy over a single areas. This means large supernormal profits, welfare loss, higher prices.
What issues might deter collusion?
- Well regulated, CMA, therefore a formal agreement may be unlikely as there are risks of being prosecuted.
- Price leadership, price rigidity, firms wont neccesarily cut prices and take short term increases in profits.
- If there are less barriers to entry than collusion will be more likely as the market is more contestable and new entrants are more threatening.
- Buisness objectives, they may non-profit organisations.
- Firms may be looking to outcompete other firms in the long run through increases in diversity, branding and better quality prodcuts.
- Whilstleblowing policies, gain immunity when in a collusive agreement, tell the CMA.
- Risks of fims not following agreements
- Collusion is more likely to happen where there are only a few firms, they face similar
costs, there are high entry barriers, it is not easy to be caught and there is an
ineffective competition policy. Moreover, there should be consumer inertia. All of
these factors make the market stable.
Price leadership
Collusion through communication with one and other, signalling intent. Firms could raise prices in the hope other firms join then.
WHAT determines wether this is likely.
- Number of firms in the market, less firms means its more likely.
- Illegal CMA and resouces/but less likely to be caught
- Ability to collude in other ways, formal arrangements may be better
- Short run risk
Costs of Oligopoly
- Basic model of a Oligoploy suggests that higher prices and profits and inefficiency may result in a misallocation of resources compared to the outcome in a competetitive market.
- If firms collude there is a loss of consumer welafer, since prices are raised and output is reduced
- Collusion could reinforce monoploy power of exisiting firms and make it hard for new firms to enter. The absence of competition means efficiency falls, this increases the average cost of prodcution
- Limitec consumer choice due to high concentration ratio, barriers to entry defer other firms.
Advtantages of Oligopoly
- Oligopolies can earn signifcant supernormal profits so therefore they may invest more in research and development, this can yield positive externalities, and make the monoply more dynamically effcient in the long run. There could be more invention and innovation as a result.
Moreover firms are more likely to innovate if they can protect their ideas this is more liekly to happen in a market where there are high barriers to entry
Higher profits could be a source of government revenue
Industry standars could improve, this is especially true in pharmaceutical industry and for car safety tech, firms can collabrote on tech and improve it, stops diplicate reaserch.
Battle for market share leads to high spending on reaserch and development, leading to innovation.
Dominant firms exploit internal economies of scale which leads to falling costs and can in theorty be passed on to consumers with lower prices.
Price wars are beneficial
EVAL
- Price wars dont neccesarily benefit all consumers, depending on the scale of the price war, furthermore can lead other firms to leave the market making it even more concentrated then it was before.
- Depends on the objectives of the buisnes, investment decisions and output decisions and that influence on price.
- Depends on the extent of contesablitly, can small firms challange exitisng firms, is their a threat of competition.
- Depends of effectiveness of regulation in promoting consumer welfare.
Dynamic efficienty
Over time due to changes in technology and innovation, we can show this on the LRAC curve.
Allocative efficeny
When MC = AR
What is game theory
This is a branch of applied mathmatics in which analyses situation in which parties make decisions that are independant from one and another.
Dominant strategy
When one choice gives better result than the other.
Nash equalibrium
This is where each player has nothing to gain by changing strategy, given the choices of the other player.
Collusion and game theory
Firms can gain the optimal area in the long term if they collude and both set prices high at the same level.
HOWEVER
Without collusion it is rational for both firms to price low, if one firm lowers price, the other will likely follow. If one firm raises prices then they will lose out.
