Oligopolies Flashcards
what are the characteristics of oligopolies?
- high barriers to entry e.g strong brand loyalty
- firms are interdependent
- differentiated goods
- 5- firm concentration ratio greater than 60%
- price makers
- price leadership
- there may be imperfect information
- high barriers to entry/exit e.g brand loyalty, start up costs
- non price competition
- profit maximisation isnt the sole objective
- firms actions are influenced by another firm
what is market share?
the proportion of total sales in a market accounted for by a brand, product or company
how do you calculate firm concentration ratio?
- add together the total sales for each of the dominant firms in the industry
- calculate the sum of the total sales of the industry
- total sales of dominant industries/ sum of the total sales of in industries
why do only a few firms have over 60% of market share?
- high barriers to entry e.g strong brand loyalty
- firms are interdependent
- differentiated goods
- firms dont make decisions on their own- make decisions based on their rival firms actions
- leads to price rigidity
why does price rigidity occur?
firms dont make decisions on their own- make decisions based on their rival firms actions
why do firms charge at a fixed price?
- firms dont want to change their price because if they increase their price, demand will decrease significantly
- other firms will not follow this price rise as theyre looking to gain market share
- the firms that have raised their price is gonna suffer- revenue will decrease
draw an oligopoly diagram?
what is a sticky price?
price that firms tend to charge at
why is the graph both elastic and inelastic on a kinked demand curve diagram
- a decrease in price will lead to a small increase in demand. the decrease in price isnt proportional to the increase in demand
- this is because other firms will follow looking to protect their market share→ price war
- total revenue will fall
- no change in market share
draw a diagram which shows why firms dont need to change price in an oligopoly?
firms dont need to change price- draw MR curve
what is the condition for an oligopolist to always charge price at P1?
as long as costs change within the vertical gap between the two MR lines , a profit maximising oligopolist will always charge a price at P1
why is there more non price competition in an oligopoly?
- firms may still try raise or reduce their prices to gain market share- price competition // price war
- more non price competition due to price rigidity
why is there a strong temptation to collude?
- strong temptation to collude to break interdependence as firms are always looking at what their rivals are doing which can be frustrating
- so they dont have to be worrying about rivals prices
- when firms do this they can act as a monopoly and increase prices
what is the limitation of the kink curve?
doesnt map interdependence to the same level that game theory does
unlikely that every firm reacts in the same way
real world evidence suggests that in competitive oligopolies when demand is stable they respond rapidly to changes in costs
dont know how the original price is arrived at
what is game theory?
the cartel members have to trust that the other members will stick to the agreement
scenario:
- there are two firms and each firm is facing the same pricing decisions
whether to charge a high price or low price
- put pay offs/profit they receive per month depending on the options they pick into a table
how would you draw the game theory for oligopolists on a diagram?
left hand number is always the pay off for the firm on the left, right hand number is always the pay off for the firm at the top
how do you solve this prisoners dilemma diagram?
- what each firm does depends on the action of the other firm
- if both businesses chose to collude, the two firms can increase their joint profits
what may happen if two firms agree to collude at the higher price?
- if they agree to collude at the higher price there is an incentive for one of the businesses to undercut the other and charge at a lower price
- this means that consumers would go for the lower price that the other business is charging, inflicting a small loss on the other business charging the higher price
how would you evaluate the game theory?
- becomes relevant when there are relatively few firms
- assumes rational agents are looking to maximise their own self- interest
- can over simplify complex decisions, when there are more than two rival firms in a market the complexity increases`
what is a cartel?
a cartel is a formal agreement among firms in an oligopolistic industry
what do cartels do?
cartel members agree on prices, total industry output, market shares, allocation of customers, allocation of territories , division of profits
what are the key aims of collusion in an oligopoly?
- businesses in a cartel recognise their interdependence and act together- aim is to maximise joint profits
- lowers the costs of competition
- reduced uncertainty - increase producer surplus and shareholder value
when are price fixing cartels likely to happen in an oligopoly?
- industry regulators are ineffective- regulatory failure
- penalties for collusion are relatively low to gain in profits - fines dont act as a proper deterrent
- price inelastic demand- higher prices lead to increased revenues
- firms can communicate and trust eachother well
what causes cartels to breakdown?
- enforcement problems
sell under the cartel price - Falling market demand
- Successful entry of non cartel firms into an industry undermining a cartels control of the market
why may there be enforcement problems in a cartel
- cartel aims to restrict production to maximise total profits
- but each individual seller finds it profitable to expand their production
- other firms who arent members of the cartel may take a free ride by selling under the cartels price
what are the main costs of cartel behaviour?
- Damages consumer welfare
- X Efficiencies leads to higher unit costs
- less incentive to innovate - loss of dynamic efficiency
- harder for new business to enter the business- reduces market contestability in the long run
why may cartel behaviour damage consumer welfare
- Higher pries leads to loss of consumer surplus
- Loss of allocative efficiency
- Regressive impact on poorer households
what are the types of price competition?
price wars
predatory pricing
limit pricing
what is predatory pricing?
strategy of driving competitors out of market by setting low prices or setting low prices or selling below average variable cost
what is a price war
a repeated cutting of prices below that of competitors as companies compete to offer the lowest price in the market
what is limit pricing?
- pricing by a firm to deter entry or the expansion of incumbent firms
- the limit price is below the short run profit maximising price but above competitive level
what is price leadership in an oligopolistic industry
where the largest firms initiate price changes while the smaller firms follow suit
what factors may stop a firm from colluding
CMA
difficulties in reaching an agreement
a lack of trust -> can lead to less profit than a non collusive oligopoly as a result of fiercer competition if a member breaks an agreement
potential for new entrants due to supernormal profit
new entrants can exploit technological advances
what is overt collusion and what does it allow firms in an oligopolistic industry to do
exists when a firm makes a formal agreement that restricts competition
this enables them to behave like a monopoly by providing the same offer such as same price
removing of competition allows firms to benefit from supernormal profit
what could the effect of collusion be in terms of new entrants
collusion can leave oligopolies open to new entrants arriving with better technological innovations
how can the new entrants problem be solved in overt collusion
by utilising cooperation through sharing of research and development, joint technology and training of staff it prevents new entrants coming in
what is tacit collusion
an informal agreement
is a collusion between competitors which do not explicitly share information and achieving an agreement about coordination of conduct
tacit collusion= price leadership
hard to prove
what is a non collusive oligopoly/ competitive oligopoly
firms are competing
each firm will make decisions independently but with an awareness that outcomes will be determined by a rivals decision aswell
what is the dominant strategy in game theory
where a players best strategy is independent of those chosen by others
the dominant strategy is the one where upon choosing this option, the outcome could mean it benefits that firm the most out of all of the other options or they only loose out a small amount compared to choosing the other options
the dominant strategy is the same for both firms
why may a firm not collude with reference to game theory
they wouldve benefitted from colluding however it is risky as they cant trust trust that the other firm wont act in their own best interest so they will undercut the other firm to avoid that risk
what is the nash equilibrium in game theory
when each firm chosen strategy maximises payoffs given the other firms choice, so that firm has an incentive to alter behaviour
they dont have an incentive from deviating from their own strategy even if they know the other players strategy
which choice do both firms end up choosing in game theory
they both end up choosing the low price (which is the dominant strategy) even though the higher price wouldve given them a better outcome
though after seeing what the other firm has done they are reassured that they made the right choice
draw the demand diagram for a competitive oligopoly
draw the diagram to show supernormal profit being made in a competitive oligopoly
when is supernormal profit made in a competitive oligopoly and why
in the SR and LR SNP is made
this is due to high barriers to entry which deter new entrants
what efficiencies are or arent there in a competitive oligopoly and why
no productive efficiency because they arent producing at the bottom of the AC curve
no allocative efficiency as price is greater than MC
where does MC go on a competitive oligopoly demand diagram and why
MC goes through vertical gap between two MR lines
MC has to move within this gap for there no be no change in price and quantity
within this gap oligopolies would accept increases in costs
give examples of non price competition
loyalty schemes such as free gifts
advertising
reliability
design and quality
branding
good customer service
good after sales service
what are the advantages of oligopolies
-less price volatility so less uncertainty
-possibility for dynamic efficiency -> SNP can be reinvested in Research and development or in new technology, better production techniques which may lead to lower costs of P and therefore prices
-lack of firms so theres large scale production leading to internal economies of scale
-competition through differentiation which increases choice-> caters for many different tastes
what are the disadvantages of oligopolies
-barriers to entry-> fewer firms so may lead to decreased choice
-no allocative efficiency
-absence of new competition, firms may become complacent -> lack of dynamic efficiency
-encourages higher expenditure on non price competition which may lead to higher costs and therefore higher prices
