oligopoly

Question 1

characteristics of oligopoly

Answer 1

• 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.

Question 2

eg.

Answer 2

UK airline industry

Question 3

kinked demand curve p1

Answer 3

Firms don’t want to change their price, different elasticities around price p1. Price elastic above p1, price inelastic below p1.

Question 4

so if price rises from p1 to p2

Answer 4

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.

Question 5

If price decreases from p1 to p3

Answer 5

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.

Question 6

In both cases, producing MC = MR will lead to

Answer 6

the firm charging a price of p1. - Firms don’t NEED to change their price.

Question 7

Nash equilibrium

Answer 7

two underlined values for revenue/ output which can last in the long term

Question 8

game theory

Answer 8

• 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.

Question 9

conclusions

Answer 9

• Price competition does occur in reality
• Non price competition
• Temptation to collude

Question 10

Competitive oligopoly

Answer 10

Price or non-price competition

Question 11

Factors promoting competitive oligopoly

Answer 11

Large number of firms, I.e. a less concentrated oligopoly
New market entry possible
One firm with significant cost adv
Homogenous good
Saturated market

Question 12

eval comp oligopoly

Answer 12

pros/ cons of competitive markets/ outcomes ( + static efficiency, - DE)

Question 13

Collusive oligopoly:

Answer 13

Overt or tacit

Question 14

Factors promoting collusive oligopoly:

Answer 14

• Small number of firms
• Similar costs
• High entry barriers
• Ineffective competition policy
• Consumer loyalty
• Consumer inertia
• reduce uncertainty which firms face

Question 15

Barometric firm price leadership

Answer 15

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.

Question 16

Types of price competition

Answer 16

• price wars
• predatory pricing
• limit pricing

Question 17

Price wars

Answer 17

● 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

Question 18

Predatory pricing

Answer 18

● 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

Question 19

Limit pricing

Answer 19

● 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.

Question 20

Efficiency in oligopoly

Answer 20

• 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