oligopolies Flashcards
what is an oligopoly
where a few large firms dominate the industry with each firm having significant market power and the concentration ratio of the top 5 firms is usually high
what is the concentration ratio
collective market share of individual firms in a market
what does the cr give an indication of
how competitive the market is
in the exam, how do you write cr
n: market share
what are the characteristics of an oligopoly
A small number of sellers dominate the market (typically top 5 firms with >60% CR)
Firms try to maximise profits – depending on how they expect rivals to react
Economies of scale would mean that not many firms can operate at/near the MES (this often results in an oligopolistic mkt)
High entry barriers e.g. sunk costs and brand loyalty
Firms try to differentiate products to get some price-making power but products are often very similar
Non-price competition (usually) – brand image and advertising
Interdependence – always take rivals reactions into account when making decisions
Prices will tend to be more rigid due to interdependence (stay steady)
Firms may be rivals (compete) or they may co-operate (collude) although colluding is illegal
what is interdependence
firms will always take rivals reaction into account when making decisions
why is colluding bad
firms can come together and set prices meaning they can exploit consumers because if they all charge a high price for a good then they’re forced to pay that price even if not socially optimal so they can maximize their profit
what’s an example of an oligopoly
supermarkets like aldi is the price leader as it charges lowest prices so supermarkets like tesco would want to price match
how do they have non- price competition
Compete by being a first mover (doing something first)
Developing brand loyalty
Try gain new markets
Sales promotion
Product differentiation
Location
why is the demand curve kinked
Above the kink: MR is relatively higher (since demand is elastic).
Below the kink: MR falls sharply (since demand is inelastic).
Discontinuity (Gap) in MR: At the kink, the MR curve has a vertical gap because the slope of the demand curve changes suddenly.
not gaining as much additional revenue
what may break out between competitors
price wars
what may this result in for firms
very little change in market share but a significant loss in profits, due to the lower prices generated by the price war
what strategy do oligopolies use
dominant strategy
what is the dominant strategy
Best move to make regardless of what your opponent does
why do firms use dominant strategy
help avoid price wars, can achieve optimal outcomes in a competitive setting
what is nash equilibrium
the optimal outcome that will occur when both firms make decisions simultaneously and have no incentive to change- don’t deviate from initial strategy
how do firms reach nash equilibrium
competition, tacit collusion, cartels
what is a cartel
a formal agreement between firms (often to fix prices) which is illegal
what is a tacit
(informal collusion- no formal agreement) play by certain rules of competition that ensure higher prices or market stability without explicit communication
example of a cartel
OPEC who are an international cartel made up of 12 oil producing countries that manipulate oil supplies to control prices
example of a tacit
When Tesco raises or lowers prices, other firms gradually adjust rather than aggressively undercutting each other- this supports kinked demand theory
why is this a tacit collusion
No formal agreement- firms do not directly communicate or form a cartel.
Firms still compete but avoid destructive price wars.
Interdependence- each firm reacts to competitors’ pricing strategies.
what 2 things can firms do when they’re not colluding
1) match price- if one firm cuts their prices, then the other firm follow suit causing inelastic demand
2) ignore change- if 1 firm raises their prices, others maintain the same price causing elastic demand
why is the marginal revenue curve shaped the way it is on the kinked demand curve
example of market share- cinemas
cineworld- 24.8%
odeon- 24.2%
vue-20%
totals at 69% of the market in 2017
what is your depends upon argument ho
How contestable is this industry? Can firms attempt to get into that top 5?
e.g aldis entry and growth over the years have allowed them into the top 5 forcing other supermarkets to lower their prices and ‘price match’ questioning the real rigidity of oligopolies pricing strategies. Shows that firms can challenge the incumbent ones- pushed Morrisons out of top 5.
