oligopoly Flashcards
characteristics of oligopoly
- Few firms dominate the market – no more than 7 firms collectively 70% Market Share
- High concentration ratio
- Differentiated goods
- Firms are price makers
- High barriers to entry – tend to be brand loyalty, sunk costs, etc
- INTERDEPENDENCE – firms make their decisions based on how rivals will react/ act = price rigidity
- Non price competition due to price rigidity
- Profit maximization not sole objective at all times.
eg.
UK airline industry
kinked demand curve p1
Firms don’t want to change their price, different elasticities around price p1. Price elastic above p1, price inelastic below p1.
so if price rises from p1 to p2
So if price rises from p1 to p2, q1 falls WAY more than q2, because of interdependence – other firms will not follow this price rise and undercut this firm, so demand falls, market share falls, revenue decreases.
If price decreases from p1 to p3
q1 to q3, as other firms are going to follow and get into a price war with this firm – so not in the best interests as revenue still falls.
In both cases, producing MC = MR will lead to
the firm charging a price of p1. - Firms don’t NEED to change their price.
Nash equilibrium
two underlined values for revenue/ output which can last in the long term
game theory
- Firms make decisions based off rivals
- The underlined value tends to be the most rational to produce at, therefore there is price rigidity at this value.
- However, ‘temptation to collude’ will remove competition and fix prices at two ‘high’ prices – which will maximise revenues the most
- Incentive to cheat on collusive agreement, as this would lead to higher profits and market share – so could be evaluated that collusion may not last in the long term.
- Could also be regulated by authorities.
conclusions
- Price competition does occur in reality
- Non price competition
- Temptation to collude
Competitive oligopoly
Price or non-price competition
Factors promoting competitive oligopoly
Large number of firms, I.e. a less concentrated oligopoly
New market entry possible
One firm with significant cost adv
Homogenous good
Saturated market
eval comp oligopoly
pros/ cons of competitive markets/ outcomes ( + static efficiency, - DE)
Collusive oligopoly:
Overt or tacit
Factors promoting collusive oligopoly:
- Small number of firms
- Similar costs
- High entry barriers
- Ineffective competition policy
- Consumer loyalty
- Consumer inertia
- reduce uncertainty which firms face
Barometric firm price leadership
where a firm develops a reputation for being good at predicting the next move in the industry and other firms decide to follow their leader.
Types of price competition
- price wars
- predatory pricing
- limit pricing
Price wars
● These occur in markets where non-price competition is weak; where goods have weak brands and consumers are price conscious. They also occur when it is difficult to collude.
● A price war will drive prices down to levels where firms are frequently making losses. In the short term, firms will continue to produce if their AVC is below AR but in the long run, they will leave the market and prices will have to rise since supply falls.
● It lowers industry profits
Predatory pricing
● This occurs when an established firm is threatened by a new entrant or if one firm feels that another is gaining too much market share.
● The established firm will set such a low price that other firms are unable to make a profit and so will be driven out the market. The existing firm is then able to put their price back up.
● This is illegal and only works when one firm is large enough to be able to have low prices and sustain losses
Limit pricing
● In order to prevent new entrants, firms will set prices low (the limit price). The price needs to be high enough for them to make at least normal profit but low enough to discourage any other firm from entering the market.
● The greater the barriers to entry, the higher the limit price. It is mainly used in contestable markets.
● The drawback of this is that it means firms cannot make profits as high as they would be otherwise be able to.
Efficiency in oligopoly
- firms will be statically inefficient as they are not productively to allocatively efficient
- dynamically efficient as SNP, and also incentive to invest due to competition
- exploit economies of scale and likely monopsony power like supermarket bruds
