Market Structures (Oligopolies)

Question 1

State 4 characteristics of oligopolies

Answer 1

Any 4:

1. A market dominated by a few firms with a high concentration ratio
2. High barriers to entry (so they can retain supernormal profits)
3. Differentiated products (similar but not identical)
4. Interdependent firms, meaning the actions of each firm affect each other
5. Firms can either compete or collude

Question 2

What is competitive behaviour in an oligopoly?

Answer 2

When firms don’t cooperate/collude, but compete with each other (mostly on price)

Question 3

What is formal collusion? What is it also known as?

Answer 3

An agreement between firms to cooperate with each other, mainly on pricing. It’s also known as a cartel, and is illegal

Question 4

What is informal/tacit collusion?

Answer 4

When firms collude without any formal agreement, it is illegal. It happens when all firms know it’s within their best interests not to compete on price, provided all other firms do the same

Question 5

How can firms in an oligopoly achieve dynamic efficiency? What do they normally do?

Answer 5

They have the resources to invest and innovate to achieve dynamic efficiency, but they tend not to

Question 6

How are firms in collusive oligopolies able to make supernormal profits?

Answer 6

At the expense of the consumer, because even though they could afford to lower prices, they don’t and therefore maintain a supernormal profit

Question 7

Is a firm likely to be better or worse off if it raises its prices, according to the kinked demand curve?

Answer 7

Worse off, because other firms won’t follow suit

Question 8

In the kinked demand curve, if a firm lowers its prices, it will not gain any market share as other firms will also lower their prices. What effect does this have on elasticity?

Answer 8

When prices are decreased, demand is inelastic

Question 9

Will a firm be worse or better off as a result of decreased prices, according to the kinked demand curve?

Answer 9

Not much effect, as it won’t gain any market share because other firms will generally also decrease prices , but profits will also decrease so it could be argued that firms will therefore be worse off.

Question 10

The conclusion of the kinked demand curve is that by changing prices, firms will be worse off either way. What does this do to stability in the market? And why?

Answer 10

It causes price rigidity/stability in oligopoly markets. Because firms are not incentivised to increase OR decrease prices

Question 11

What are the 3 things the behaviour of firms in an oligopoly depends on?

Answer 11

1. The objectives of firms (profit maximisation vs sales maximisation)
2. The degree of contestability in the market (e.g. - barriers to entry?)
3. Government regulation of oligopolies

Question 12

What are the 3 different possible outcomes for oligopoly firms?

Answer 12

1. Price stability (shown through the kinked demand curve)
2. Price wars (competition over prices)
3. Collusion for higher prices

Question 13

State 3 problems that can arise from collusion in oligopoly markets

Answer 13

1. Higher prices for consumers
2. New firms discouraged from entering the market (collusion can act as a barrier to entry)
3. Easy profits from collusion

Question 14

If a firm was to be productively efficient, at what point (equation) would they need to operate at, and why therefore, can a firm in an oligopoly market not achieve productive efficiency?

Answer 14

Productive efficiency — P = AC (price equal to average costs)

A firm in an oligopoly market cannot achieve productive efficiency because their price is greater than average costs (P > AC)

Question 15

If a firm was to be allocatively efficient, at what point (equation) would they need to operate at, and why therefore, can a firm in an oligopoly market not achieve allocative efficiency?

Answer 15

Allocative efficiency — P = MC (price equal to marginal costs)

A firm in an oligopoly market cannot achieve allocative efficiency because their price is greater than marginal costs (P > MC)