Oligopoly

Question 1

key aims of collusion

Answer 1

1. maximise joint profits
2. reduce costs of competition e.g. wasteful marketing wars
3. reduce uncertainty and increase profits to increase shareholder value and share price

Question 2

6 conditions for effective collusion

Answer 2

1. industry regulation is weak
2. penalties for collusion are low RELATIVE to potential gains in SNP from colluding
3. firms can communicate well, trust each other and have similar strategic objectives
4. involved firms have a high % of total sales, making it easier to control market supply
5. industry products are standardised and measurable to ensure each firm abides by output quota
6. brand loyalty is strong so PED is LOW consumers won’t switch when prices are increased - erodes incentive to cheat

Question 3

reasons why cartels break down

Answer 3

1. enforcement is hard due to hard-to-measure output
2. falling market demand in recession - lower sales puts downward pressure on prices, and cash flow; low cash flow is incentive to discount
3. exposure of cartel by whistle-blowing members/ex-members (incentive since they get reduced penalty)
4. trust breaks down particularly due to divergence of strategic objectives
5. creative destruction - successful entry of non-cartel firms in the market who bypass BTE and undermine market control

all of these factors INCREASE THE INCENTIVE TO CHEAT

Question 4

cons of collusion

Answer 4

1. reduced consumer welfare - loss of AE and higher inequality
2. reduced productive/X efficiency and dynamic efficiency
3. erects artificial BTE

Question 5

pros of collusion

Answer 5

1. some acts may increase social welfare and generate positive externalities e.g. improves production, distribution, product standards
2. producer co-ops in LEDCs have more monopsony bargaining power for fairer prices, may reduce extreme income poverty
3. profits gained can be reinvested to increase dynamic efficiency or increase wages and purchasing power (SOL)

Question 6

how is P>MC in monopolistic competition if only normal profits are made?

Answer 6

the difference between perfect comp and monopolistic/monopoly is that the demand curve is downward sloping for the latter!

downward slope means more output can be sold only by reducing the prices, so price (equal to AR) > MR (this is why your AR curve is higher than MR in imperfect comp diagrams)

if profit maxed at MC = MR, but price is higher than MR, price must ALSO be higher than MC!

alternatively: in LR, monopolistically competitive firms operate on the declining portion of their ATC curves (MES not reached yet) so MC < ATC (remember MC is lower than ATC before it intersects ATC at its lowest point and starts to increase past that)

hence for P to equal ATC, price must be above MC

remember that profit is determined by ATC=P, NOT by MC!!