Oligopolistic competition

Question 1

Characteristics (3 points)

Answer 1

1. High Market Concentration ratio (x-firm concentration ration = the percentage of the market supplied bu the larges x firms) (Herfindahl index - closer to 1, the closer to monopoly)
2. Firms are interdependent.
3. Barriers to entry and exit do exist.

Question 2

Why is Sweezy’s kinked demand theory kinked at the current price level?

Answer 2

1. If a firm increases prices, others won’t follow suit and it will lose lots of business.
2. If a firm decreases prices, others will follow suit and a price war will ensue - won’t gain anything.

Question 3

Prisoners’ dilemma

Answer 3

When individual firms act in their own best interests yet this does not result in the optimal level of welfare.

Relevant because collusion cannot be ratified by contract because it is illegal, therefore each participant has an incentive to cheat.

Question 4

Why are cartels limited in life span (3 reasons)

Answer 4

1. Incentive to cheat
2. new firms undermine the cartel
3. Increasing power of regulators like the OFT

Question 5

Dominant Firm Model

Answer 5

1. Form of Tacit collusion
2. Dominant firm sets prices and lets firms supply as much as they like then supplies for the remaining market demand.
3. Dominant firm is usually a low cost producer.

Question 6

Barometric Price Leadership

Answer 6

1. When changes in the macroeconomic conditions cause industries to alter their prices.
2. High prices may not be the result of JUST tacit collusion between firms agreeing on level of price increases, but ALSO customer inertia

Question 7

Complex monopolies

Answer 7

When a market is served by two firms which are not interconnected, but engage in conduct, whether by collusion or not, which is likely to restrict, distort or prevent competition.

Question 8

Is collusion ever good?

Answer 8

YES

1. Airbus is a joint venture of European firms… good otherwise Boeing would be a monopoly.

Question 9

Pricing strategies (5 types)

Answer 9

1. Entry level pricing (charging highest possible amount that still deters new entrants - below π max).
2. Predatory Pricing
3. Marginal Cost Pricing (Price = marginal cost —- allocatively efficient
4. Cost plus pricing — most realistic?
5. Non-price competition

Question 10

What is the difference between the Cournot Model and the Bertrand Model of Duopoly?

Answer 10

Cournot model assumes that the two firms assume each others output and produce accordingly, whilst the Bertrand Model assumes that each firm assumes the other will not alter prices in response to price cuts,

Question 11

What is a Duopoly?

Answer 11

When the market consists of just two firms producing homogenous products.

Question 12

Why is MC pricing difficult to achieve? (5 points)

Answer 12

1. Fails to take into account changes in demand.
2. In integrated systems of production it’s hard to work out MC.
3. Industries with very high start up costs but very low marginal costs could run into financial deficits.
4. Doesn’t take into account externalities.
5. Might actually make abnormal profits and actually encourage firms to enter the industry anyway.

Question 13

Criticisms of Kinked Demand theory

Answer 13

1. Good theory, but little evidence in real life.

2. Doesn’t explain how the price got to that level.

Question 14

What is tacit collusion?

Answer 14

When firms undertake actions that are likely to minimise a competitive response.

Question 15

When is collusion more likely to occur? (6)

Answer 15

1. Small number of firms
2. Market demand is not too variable.
3. Demand is fairly inelastic
4. each firm’s output can be easily monitored.
5. Firms have similar costs so none has an incentive to start a price war.
6. Products are fairly homogeneous.

Question 16

What is interdependence?

Answer 16

The best strategy for any one firm to follow will depend on the actions of its rivals.