oligopoly

Question 1

characteristic 1: what is the number & size of firms?

Answer 1

few large firms dominating the market

Question 2

characteristic 2: what is the nature of products?

Answer 2

• highly differentiated (can be real and or perceived differences)
• homogenous (raw materials)

Question 3

characteristic 3: what is the nature of market information for both consumers & producers?

Answer 3

• high degree of imperfectness of market knowledge on the ends of both the consumers & producers

Question 4

characteristic 4: presence of barriers to entry

Answer 4

• high barriers to entry continue in the long run

Question 5

what are the types of barriers to entry present in oligopolies?

Answer 5

• artificial barriers to entry
• natural barriers to entry

Question 6

what are some artificial entry barriers that oligopolistic firms can enact?

Answer 6

• strong brand prestige & reputation that incumbent firms possess

Question 7

what are some natural entry barriers present in an oligopolistic industry?

Answer 7

• extremely high fixed costs required to set up manufacturing plants
• high iEOS

Question 8

why oligopolistic firms CANNOT earn subnormal profits in the LR?

Answer 8

• if an oligopolistic firm is earning subnormal π in SR equilibrium, it will shut down in the LR when all its fixed costs become variable costs

Question 9

why can oligopolistic firms earn supernormal π even in the LR?

Answer 9

• if an oligopolistic firm is earning supernormal profits in SR equilibrium,
• the high entry barriers that continue into the LR will prevent new firms from entering into the industry to compete for the firm’s market share

Question 10

explain why price rigidity is present in an oligopolistic market. [5]

Answer 10

1. due to the small number of large firms in the oligopolistic market, the market share of each firm is very large
2. this results in mutual interdependence between the firms, whereby the actions of any 1 firm has a significant impact on the revenues & hence π of the other firms
3. when a firm lowers its price, it will gain some market share form its rivals, thus hurting their rivals’ revenue & profits
4. rival firms will most likely react by also lowering their prices, thus preventing the firm from getting a larger market share
5. this causes the firm’s revenue & hence profits to be likely to fall
6. as a result, oligopolistic firms are unlikely to lower prices as a form of price competition
7. however, if a firm were to raise its prices, its rivals are unlikely to follow suit, as they can simply enjoy a higher market share without changing their price
8. as a result, oligopolistic firms are also unlikely to raise their prices once they have set it, giving rise to price rigidity

Question 11

will oligopolistic firms be productively efficient at a firm level? [5]

Answer 11

1. in order to be productively efficient at a firm level, firms have to be operating on their LRAC curve
2. in the long run, oligopolistic firms can earn supernormal profits due to the presence of high BTE
3. this allows productively inefficient oligopolistic firms to continue to make supernormal π in the LR, & still remain in the industry
4. however, some oligopolistic firms may still be productively efficient
5. nonetheless, being large firms, oligopolistic firms are more likely to suffer from X-inefficiency, & are thus therefore likely to be productively inefficient

Question 12

will oligopolistic firms be productively efficient at the economy level?

Answer 12

1. to achieve allocative productive efficiency at the economy level, all firms in all industries must be both operating on their LRAC curves & produce at the MES
2. in theory, oligopolistic firms can be productively efficient at the firm level, but may not always be, & are in fact unlikely to be
3. however, assuming that they are productively efficient at the firm level, it is possible for oligopolistic firms to still allow the economy to achieve productive efficiency,
4. as it is still possible for oligopolistic firms to produce at their MES
5. however, as most oligopolistic firms typically maintain some spare capacity in order to be in a position to absorb a rival’s market share, they typically produce an output below MES
6. hence, while it is theoretically possible that oligopolies are consistent with the achievement of economy-level productive efficiency, it is unlikely that this will be case

Question 13

will oligopolistic firms achieve allocative efficiency in the long run? [2]

Answer 13

• since oligopolistic firms are price setters, P=AR, where AR > MR
• & as profit maximisers, they will produce where MR=MC
• hence, for oligopolistic firms, P>MC,
• in the long run, when P>LRMC, allocative efficiency will not be achieved

Question 14

what is the definition of 3rd degree price discrimination?

Answer 14

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Question 15

what are the 3 conditions that must be met before an oligopolistic firm can practice successful 3rd degree price discrimination?

Answer 15

1. the firm must possess the ability to set prices
2. at least 2 different groups of consumers must exist in the market, with different PED for the good, WITH the firm being able to determine which group does each consumer fall into
3. the firm must be able to keep the different groups of consumers separate in order to prevent reselling of the good between consumers in different groups

Question 16

how does 3rd degree price discrimination affect π? [4]

Answer 16

1. by selling the good at a lower price to consumers with a price elastic demand, the increase in quantity demanded is more than proportionate to the decrease in price, resulting in higher total revenue for the firm
2. by selling the good at a higher price to consumers with a price inelastic demand, the decrease in quantity demanded is less than proportionate to the increase in price, resulting in higher total revenue
3. by charging prices to each group of consumers such that the rise in quantity demanded in 1 group matches the fall in quantity in 1 group, the firm can keep its total output unchanged at the π-maximising level. → Hence, total costs remained unchanged
4. as a result of higher total revenue & unchanged total cost, the firm’s profit rises

Question 17

how can 3rd degree price discrimination affect consumers’ welfare & equity?

Answer 17

1. it causes consumers whose demand for the good is more price inelastic to end up paying a higher price for the good, & at the same time causing consumers with a more price elastic demand to pay less
2. this can potentially be seen as a fairer outcome given that low-income consumers tend to have a more price elastic demand for goods, given the high proportion of household income spent
3. however, the loss in consumer surplus (CS) by those who end up paying more would be greater than the gain in CS by those who pay less, as evidenced by the higher profits of the firm. Hence, 3rd degree price discrimination can be seen as inefficient