Oligopoly Flashcards
Characteristics of Oligopoly
- High Barriers to Entry & Exit: Make the market less competitive.
- High Concentration Ratio: Only a few firms supply majority of the market (e.g supermarket industry). High concentration ratio = less competitive
- Interdependence of Firms: Actions of 1 firm affect another firm’s behaviour
- Product Differentiation: Differentiate their products from other firms using branding. Degree of product differentiation can change how far the market is an oligopoly
Collusive & Non-Collusive Oligopoly
Collusion: Occurs if firms agree to work together on something
- E.g might choose to set price or fix the quantity of output, minimises competitive pressure
- Leads to a lower consumer surplus, higher prices & greater profits for firms
- Allow oligopolists to act as monopolist & maximise their joint profits
- Firms in an oligopoly have strong incentive to collude, can maximise their own benefits & restrict their output, to cause the market price to increase
- Deters new entrants & is anti-competitive
- More likely to happen when there are only a few firms, they face similar costs, high entry barriers, not easy to be caught, ineffective competition policy & consumer inertia
- All of these factors make the market stable
Non-Collusive: Occurs when firms are competing
- Establishes a competitive oligopoly
- More likely to occur where there are several firms
- 1 firm has significant cost advantage, products are homogeneous & market is saturated
- Firms grow by taking market share from rivals
Overt & Tacit Collusion
Overt Collusion: When a formal agreement is made between firms
- Works best when there are only a few dominant firms
- Illegal in EU, US & other countries
- E.g fuel companies price fix, maximise joint profits, cuts cost of competition, reduces uncertainty
Tacit Collusion: Occurs when there is no formal agreement, but collusion is implied
- E.g UK supermarket industry, firms compete in a price war.
- Price wars harmful to supermarkets & suppliers
Cooperation & Collusion
- Cooperation allowed in the market, whilst collusion is not
- Collusion is usually with poor intentions, whilst cooperation is beneficial
- Collusion refers to market variables, such as quantity produced, price per unit & marketing expenditure
- Cooperation might refer to how a firm is organised & how production is managed
Kinked Demand Curve
- Illustrates the feature of price stability in an oligopoly
- Assumes other firms have an asymmetric reaction to a price change by another firm
- Illustrates interdependence between firms
- If price increases from P1 to P3, other firms do not react, so the firm which increases
their price loses a significant proportion of market share (Q1 to Q3) - If the firm decreases their price from P1 to P2, firm only gains a relatively small increase in market share (Q1 to Q2)
- First part of the diagram shows a relatively price elastic demand curve
- Second part shows a relatively inelastic demand curve
- When firms deviate from the rigid, equilibrium price and quantity, they enter the different demand elasticities
Cartels
Cartel: Group of 2+ firms who have agreed to control prices, limit output, or prevent entrance of new firms into the market
- E.g OPEC, fixed their output of oil since they
controlled over 70% of the supply - Cartels lead to higher prices for consumers & restricted outputs
- Some cartels might involve dividing the market up, so firms agree not to compete in each other’s markets
Price Leadership
Price Leadership: Occurs when 1 firm changes their prices, & other firms follow
- This firm is usually the dominant firm in the market
- Other firms often forced into changing their prices too, otherwise they risk losing their market share
- Explains why there is price stability in an oligopoly; other firms risk losing market share if they do not follow the price change
- Price Leader is often the one judge to have the best knowledge of prevailing market conditions
Price Wars
Price Wars: Type of price competition, involves firms constantly cutting their prices below their competitors
- Competitors then lower prices to match
- Further price cuts by one firm will lead to more & more firms cutting their prices
- E.g UK supermarket industry
Non-Price Competition
Non-Price Competition: Aims to increase the loyalty to a brand, which makes demand for a good more price inelastic
- E.g firms improve quality of their customer service,
- Special offers, free gifts, or loyalty cards, used to attract consumers & increase demand
- Advertising & marketing used to make their brand more known & influence consumer preference
- Difficult to know what the effect of increased advertising spending will be
- For some firms, it might be ineffective, incur large sunk costs, which are unrecoverable
- Brands used to differentiate between products
- If firms can increase brand loyalty, demand becomes more price inelastic, can attract & keep customers, which can increase their market share
Interdependence & Uncertainty in Oligopoly
- Game Theory: Related to concept of interdependence between firms in an oligopoly
- Used to predict the outcome of a decision made by one firm, when it has incomplete information about the other firm
- Can be explained using the Prisoner’s Dilemma, the consequences of the choice depend on what the other prisoner chooses
- Dominant Strategy: Option which is best, regardless of what the other person chooses (E.g both confess)
- Nash Equilibrium: Describes the optimal strategy for all players, whilst taking into account what opponents have chosen
- Cannot improve their position given the choice of the other
Adv. & Disadv. of Oligopoly
Advantages:
- Supernormal profits, invest in R&D, can yield positive externalities, dynamically efficient
- Firms more likely to innovate if they can protect their ideas in a market where there are high barriers to entry
- Higher profits source of government revenue
- Industry standards improve (e.g pharmaceutical industry, car safety technology) firms collaborate on technology & improve it
- Exploit EoS, lower AC of production
Disadvantages:
- Higher prices & profits & inefficiency result in misallocation of resources
- Collusion leads to loss of consumer welfare
- Absence of competition means efficiency falls, increases the average cost of production
