Oligopoly Flashcards
Define Oligopoly
Few Firms Dominating the Market
Define Concentration Ratios
Collective Market Share of the Largest Firms in an industry
What is the Ratio Written as
N : Total Market Share
N : Number of Firms [Largest Firms only] : Collective Market Share
What are the Characteristics of an Oligopoly
- High Concentration Ratio [1 : 70]
- Differentiated Goods
- Interdependence between firms
- Prices are Sticky / Rigid
- Non-Price Competition
- MC = MR is not the sole objective
What does Interdependence mean in an Oligopoly?
Decisions are made based on the actions and reactions of rival firms
What does the Kinked Demand Curve model entail?
A theory suggesting prices in oligopolies are rigid because firms match price decreases but not price increases, leading to a kink in the demand curve.
Explain the Kinked Demand Curve Model
- The curve has a kink at P1
- The point above P1 is elastic, if firms raise their prices, QD changes proportionately more and rivals will not follow, which leads to a loss in market share
- If there is a big price reduction, QD changes proportinately less as the point below P1 is inelastic, rivals will follow and match the price, which leads to smaller increases in market share
Explain the MR curve in the Kinked Demand Curve Model
The MR curve is discontinous with a vertical gap.
It shows price rigidity as even if the MC curve shifts within this gap, price and output remains the same.
This illustrates how firms do not NEED to change their price.
What is the Prisoners Dilemma?
Firms need to decide to cooperate or compete with each other in terms of prices, but do not trust each other as there is a temptation to cheat, which determines a suboptimal or rational outcome.
Explain Game Theory in relation to Interdependence
A matrix analysing strategic decision-making between interdependent firms/players.
If one firm lowers their prices, the other will definitely follow - illustrates how neither can gain a better outcome by one decision alone as there is a fear another firm will undercut them.
What are the key components in the Game Theory Matrix?
- Players [Competing Firms]
- Strategies [Price Cuts, Price Hikes]
- Payoffs [Profits]
What is the Nash Equilibrium?
Any situation where all of the participants in a game are pursuing their best possible strategy given the strategies of all of the other participants.
What are the conclusions of Game Theory?
- Price Rigidity
- Temptation to Collude & Break Interdependence
- Incentive to cheat on the Collusive Agreement
What is Collusion?
When firms in an oligopoly market structure formally [overt] or informally [tacit] agree to restrict competition by fixing prices and limiting output
Give an Example of a Cartel
OPEC - The oil-exporting countries’ cartel that coordinates oil production levels.
What factors persuade an Oligopoly to Collude?
- Small number of firms with similar costs conditions
- High barriers to entry, SNP can persist
- Consumer Loyalty
- Consumer Inertia
How do Oligopoly firms behave through a collusive agreement?
As a Monopoly
What are the disadvantages of Collusion
- Consumers are exploited through restricted quantites & higher prices
- Consumer surplus is eroded
- Can create disparities in necessity markets
- Static Inefficiency
What are some Evaluation Points about Oligopolies in a Collusive Agreement?
- Is Dynamic Efficiency really being achieved?
- What is the type of good/service?
- Diseconomies of Scale?
Why might collusion not last in the long run?
- Firms behaviour is driven by self interest and profits, increasing the incentive to cheat and undercut other firms, even though it is not rational.
- Collusion is illgeal and anti-competitve, which can lead to consequences such as fines, damaged reputation and investigations
- Prisoners Dilemma, as it can be difficult to build trust, coordination and cooperation between firms.
- Technological advancements which can alter the market as a whole in the LR may outdate previous collusive agreements.
Why is Tacit Collusion likely to act sustainable?
- Price Leadership : One dominant firm sets the price and others follow without any formal agreement
- Avoids Explicit Collusion, which is illegal
- The Price leader is likely the firm with the largest Market Share
- It can create price stability as smaller firms accept the leaders price, which reduces the risk of price wars
[All Anti-Competitve]
What factors persuade an Oligopoly to Compete?
- Large number of firms
- New Market Entry Threats
- Saturated Markets
- Homogenous Goods
- A firm with significant cost advantages is present
