Oligopolies Flashcards
Oligopoly
Few firms dominate the market and have majority market share
Four Characteristics of Oligopoly
- Products are differentiated
- High concentration ratio of supply
- Firms are interdependent so become collusive and competitive
- Barriers to entry
What does high concentration ratio of supply mean
Supply in the industry is concentrated in a small number of firms
What is the demand curve like in oligopolies
Kinked
Why is the kinked demand curve normally sloped to begin with in oligopolies
The D curve to begin with is elastic because if a firm increases their price other firms won’t follow because they will become the cheaper alternative so a small increase in price will have a large effect on demand
Why does the Kinked demand curve slope more steeply after the kink in oligopolies
It becomes inelastic because this is the point that a firm may decrease price, if this happens others will follow to remain competitive so there is a very small effect on demand when there is a small price change
Where is P1 or where does price start on the oligopoly diagram
At the demand/AR curve kink
What is the Kinked Demand curve successful in explaining
Why prices are relatively stable in oligopolies
Why don’t changes in demand or cost have an effect on price in oligopolies
Because the firms can’t change price to accommodate costs and demand changes due to the fact that increasing price is detrimental for them as customers will go to cheaper alternatives.
What is the problem with the kinked demand curve in oligopolies
It assumes an initial price set in the market
What happens to MR in a kinked demand curve
There is a gap at the kink
Calculation for n firms concentration ratios
Total sales of n firms / total size of market X 100
collusion
When firms make a collective agreement that will reduce competition
What are the advantages of collusion
- Instead of competing against each other firms work together so can set higher prices and maximise profits
- reduces uncertainty firms face
- Increases firms market knowledge
- Firms don’t have to engage in advertisement or competitive price cutting which impacts profits
Disadvantages of collusion
- Illegal so risk of punishment
- Relies on complete trust in other firm which is impossible
- May impact a firms own good business model that could profit alone
When does collusion work best and so is most likely
- Firms have similar costs and production methods and are open about them
- Few firms in the market with high barriers to entry
- Brand loyalty so customers will remain with each firm
- One dominant firm that others will follow
Overt Collusion
Formal Agreement to collude
Tacit Collusion
No Formal Agreement to collude
Cartel
Formal collusive agreement in which group of firms will mutually set prices to keep them high, rules will be laid out in a formal document with legal punishments for those who break them
What are the two ways a cartel could operate collusively
- Agree on a price for the goods and then compete freely using non price competition
- Agree to divide up the market share equally
What is the primary problem with a cartel
The more successful the cartel is the bigger the temptation to break it and the firm who breaks it first will be better off
What are the examples of tacit collusion
- Price leadership
- barometric Firm
- unwritten rules about advertising or stealing customers
Price leadership
One firm may become dominant due to size or costs, this will mean other firms will follow its example as to not start price war, so dominant firm gets to decide the price
Barometric Firm
One firm may have a reputation for being good at predicting the next move in the industry, so other firms will follow this one allowing them to set the price
When does non collusive behaviour work best
- If one firm has lower costs than others
- low barriers to entry
- products are very similar
- larger number of firms in the market
What is game theory
The reactions of one player to a change in strategy from another player, The best strategy a firm can adopt in the case of each different assumption about another firms strategy, interdependent decision making in competitive markets
What are the two strategies in game theory
Maximin - Two firms work out a strategy which makes the worst possible outcome the least bad
Maximax - Two firms work out a strategy which results in the best possible outcome
What is it called when both maximal and maximin strategies come to the same solution
Dominant Strategy
–> uncommon in real life
Nash Equilibrium
Both players have optimised their outcome based on the other players expected decision, so neither player can improve anymore and has any incentive to try and improve
What does game theory help explain in oligopolies
Explains why prices are stable as firms tend to pursue maximin policy so won’t change prices at all.
What is the prisoners dilemma
Two prisoners being questioned about a crime would be best off to both stay silent as this would be the Nash equilibrium. However there is temptation to confess as say prisoner a confesses but prisoner b doesn’t they will be better off, so in most cases both prisoners will maximin and both confess to reduce the chance of a bad outcome
How does game theory illustrate the first mover advantage in cartels
if two firms collude agreeing not to advertise the first firm to break the cartel and advertise will receive huge benefits over the other firm showing why cartels are unstable
Why can being first mover not be advantageous
- Other firms will copy very quickly and perhaps then overtake the first mover
- requires a perfect estimation of demand or how much to advertise
What are the types of price competition
- Price wars
- Predatory Pricing
- Limit Pricing
When do price wars occur
When there is little non price competition as brands lack loyalty and consumers a price conscious, similar substitute goods
Why are price wars detrimental
Firms keep undercutting each other which drives prices down to the point where firms are making a short run loss which is okay but in the long run they will be driven out of business, lowers the whole industries profits
What market engages in frequent price wars
supermarket
Predatory Pricing
When an established firm is threatened by a new entrant or a firm that is gaining market share they will set such a low price that they attract most the consumption and the other firm can’t compete and will be driven out the market
What’s wrong with predatory pricing
Illegal and only works when a firm is big enough to make losses for a short amount of time
Limit Pricing
To prevent new entrants firms will set the limit price, which is the lowest possible price whilst maintaining normal profit
What causes higher limit prices
higher barriers to entry
problem with limit pricing
Firms can’t make the full amount of profit they could, they limit themselves
psychological pricing
When firms use 99p to make products seem cheaper
Market-led pricing
Firms look at the prices charged by competitors and charge a price very similar.
Price skimming
New product is set very high to begin with to keep demand manageable and cover innovation costs and reduced gradually over time to keep demand steady, Apple
Penetration pricing
New product is set very low to get people to try it and then as demand grows price is put up
Why do oligopolies focus on non price competition
Prices are stable
Types of non price competition
- Advertising
- Loyalty cards
- Quality
- Branding
- Customer Service
- Product Development
What is the main aim of non price competition
Make demand for the product inelastic due to brand loyalty so no matter the price there will always be demand for the product
Advertising- non price competition
Creates awareness for the product and persuade a customer to buy it, will increase sales and market share, increasing profit in the long run.
Loyalty Cards - non price competition
Encourage repeat purchases at that company encouraging loyalty and rewarding it, also helps firms to gather customer buying habit data
Branding - non price competition
A well respected brand will earn peoples trust in its quality and sustainability, can increase customer loyalty and repeat buyers, also make advertising cheaper
Quality - non price competition
If a firm produces and is known for high quality goods that will encourage repeat purchases and loyalty
Problems with non price competition
- Expensive
- No guarantee of success
- Hard for small firms
Product development - non price competition
If a firm can innovate a new product superior to the rest of the market then they will receive an increase in sales
Can oligopolies be statically efficient
No because they don’t produce at the lowest point on the AC curve and they won’t put price equal to MC
Why are oligopoly firms dynamically efficient
They can make supernormal profit so have funds to invest and have incentive to because there is competition so they must innovate.
Example of oligopoly
Network providers
Three - 33%
Vodafone - 29%
O2 - 24%
EE - 27%
All Charge around £10 a month
Advantages of an Oligopoly
- Price wars help prices to be lower helping consumer surplus
- Dynamic efficiency so high R and D spending and lots of innovation
- Non price competition benefits customer in some cases
- Dominant firms can exploit economies of scale
- high supernormal profits can be taxed
Disadvantages of an oligopoly
- Collusive behaviour leads to higher prices
- high concentration ratio limits consumer choice
- non price competition can distort price mechanism
- transnational oligopolies avoid tax with schemes
Best example of overt collusion
2011 9 supermarkets were fixing the price of dairy products
