Oligopolies

Question 1

What is an oligopoly?

Answer 1

A market structure where a few large firms dominate the market

Question 2

What are some examples of oligopolies?

Answer 2

• mobile phones (and operators)
• supermarkets
• airlines
• high street banks
• soft drinks

Question 3

What curve do you use for oligopolies?

Answer 3

A kinked demand curve

Question 4

What are some more features of oligopolies?

Answer 4

• they are interdependent - meaning the action of one firm will have a direct effect on the other firms in the market
• price wars are a common feature too. However firms will try to avoid this due to lower revenue for all involved

Question 5

What is formal collusion?

Answer 5

It is illegal - when firms in a cartel make agreements amongst themselves

Question 6

What is tacit collusion?

Answer 6

When firms collude without any formal agreement or even without any explicit communication between the firms having taken place.
- an understanding by firms that it is in their best interest to restrict supply and competition
- firms monitor each others behaviour closely and unwritten rules develop which become custom and practise

Question 7

What are cartels and how may they occur in oligopolies?

Answer 7

A cartel is a form of collusion between suppliers. Firms join a cartel to increase their market power, and members work together to determine the level of output each member will produce and/or the price they will charge. By working together, the firms are able to behave like a monopolist. Enter agreements to restrict the market supply and thereby fix the price of a product in a particular industry.

Question 8

What is price leadership?

Answer 8

Occurs when a leading firm in a given industry is able to exert enough influence in the sector that it can effectively determine the price of goods and services for the entire market

Question 9

What are price agreements?

Answer 9

Formal collusion - firms in same industry make agreements to fix their prices high, so dont have price wars, so don’t loose out on profits. This is illegal and the CMA will fine companies partaking this

Question 10

What are price wars?

Answer 10

Often short lived, but intense periods when competing businesses lower their prices (undercut other firms) in a bid to win extra market share, generate more cash flow and increase total revenues - however, other firms will retaliate, and both will just end up loosing lots of profits

Question 11

What are barriers to entry?

Answer 11

There are some barriers to entry to gain significant market share. These barriers may include brand loyalty, economies of scale and high sunk costs (advertising, etc). However, these are less than a monopoly

Question 12

What is game theory?

Answer 12

Game theory is looking at the decisions of firms based on the uncertainty of how other firms will react. Shows the concept of interdependence. E.g. if a firm agrees to collude and set low output, it relies on the other firm sticking to the collusive agreement. If the firm restricts output and sets prices high, yet the other firm betrays and sets price low, the firm will be worse off. More complex when add the possibility of firms being fined by a gov regulator. Usually, the first firm that confesses to the regulator is protected from prosecution, so their will always be an incentive to be the first to confess

Question 13

What might non-price competition include?

Answer 13

• product differentiation (e.g. through better quality after sales, USP or innovation)
• advertising
• branding of products
• packaging
• different distribution systems

Question 14

What in concentration ratios?

Answer 14

The concentration ratio of a market is the combined market share of the top few firms in a market
- e.g. a ratio of 5:80 means that the 5 largest firms in the industry have 80% of the market share

Question 15

What is the difference between cooperation and collusion?

Answer 15

• Cooperation is allowed in the market, collusion is not.
• collusion is usually with poor intentions, whilst cooperation is beneficial
• collusion generally refers to market variables, such as quantity produced, price per unit and marketing expenditure - cooperation might refer to how a firm is organised and how production is managed

Question 16

What are the advantages of oligopolies?

Answer 16

• battle for market share lead to high levels of R&D, improving dynamic efficiency and yield positive externalities
• can exploit economies of scale, leading to lower average costs and lower prices in the long run
• high supernormal profits can be taxed, so more revenue for the gov to help fund public services
• industry standards could improve as firms collaborate and improve it - saving on duplicate research and development

Question 17

What are some disadvantages of oligopolies?

Answer 17

• if firms collude, there is a loss of consumer welfare, since prices are raised and output reduced
• collusion can make it hard for new firms to enter, the absence of competition means efficiency falls and this increases average costs of production
• could mean higher prices and profits and inefficiency may result in a misallocation of resources compared to the outcome in a competitive market

Question 18

What does a kinked demand curve show?

Answer 18

• Demand above the current price is elastic. If the firm increased the price, competitors would not follow these actions and instead keep their prices stable. Therefore the initial firm would see large falls in the quantity demanded and therefore lose market share and see revenue fall.
• demand below the current price is assumed to be relatively Inelastic. If the firm choose to reduce their price, this may lead to rival firms following suit immediately, initiating a price war. Initial firms therefore sees very little increase in output and will see their revenue fall

Question 19

How is price stability a feature of oligopolies?

Answer 19

The kinked demand curve shows that firms will neither increase or decrease their prices, therefore price stability

Question 20

What happens if marginal costs change in oligopolies?

Answer 20

The discontinuous marginal revenue curve.
- this is used to show the fact that even if marginal costs of production increase, firms will still keep prices constant

Question 21

How useful is the kinked demand curve theory?

Answer 21

• it takes no account of brand loyalty, which can make demand more Inelastic as some firms could increase prices and not face falling revenues
• there is no explanation of how the original price was arrived at
• this theory completely ignores the impact of non-price competition
• no account of limited price competition (e.g. special offers)