Oligopoly (3.4.4) Flashcards
What is an Oligopoly?
Where there are a few firms that dominate the market and have the majority market share, although this doesn’t mean there won’t be other firms in the market.
What are the four key characteristics of an Oligopoly?
-Products are generally differentiated
-Supply in the industry must be concentrated in the hands of relatively small number of firms (High concentration ratio)
-Firms must be interdependent
-Barriers to entry
What are some examples of industries who operate in an oligopoly market structure?
E.g. Banks, Insurance companies, department stores, supermarkets, petrol retailers, sport stores etc..
What shaped demand curve is there in an oligopoly?
Kinked demand curve
What does this Oligopoly’s kinked demand curve look like?
Slide 26
What does this kinked demand curve show/mean?
It is kinked because if a firm raises its price other firms won’t follow since they know their lower price means they are more competitive. On the other hand if a firm lowers its price other firms will follow since they want to remain competitive. This means the demand curve (AR) starts of price elastic (as firm puts up price others don’t) until it gets to P1 and becomes price inelastic (as firms lower price they do as well).
What does concentration ratio mean?
Reveals what % of the total market share a specific number of firms e.g. five firm ratio
What % of 5 firm concentration ratio would be classed as an oligopoly?
60%
What would a 100% one-firm concentration ratio be known as?
Pure monopoly
What is a pure monopoly?
A market structure in which there is a single seller selling a unique good/service
What % does the UK CMA defines a monopoly as?
When it has more than 25% market share
How do you work out 5 firm ratio?
Slide 27
What is collusion?
When firms make collective agreements that reduce competition. Firms cooperate to fix prices and restrict output
When firms don’t collude what is this called?
Competitive oligopoly
What is an example of a UK industry that is suspected of collusion?
The UK energy market
Is collusion legal?
No it is illegal in the UK as it goes against the Competition Act 1998
Why do firms do collusion?
They know that if a firm lowers their prices to gain new customers it is likely to cause other firms to lower their prices. However, if they work together, they could maximise their industry profits.
Will a firm that has a strong business model and something that sets it apart from other firms want to collude?
They won’t want to collude if they feel they can increase market share and/or charge higher prices than competitors
When does collusion work best?
-Few small firms well known to each other
-Firms aren’t secretive about costs of production
-Production methods similar
-Produce similar products
-Dominant firm which the others are happy to follow
-Market is relatively stable
-High barriers to entry
What are the two main types of collusion?
- Overt
- Tacit
What is Overt collusion?
When firms come to a formal agreement (cartel)
What is a cartel?
When there is a formal collusive agreement which is a group of firms who enter into agreement to mutually set prices. The rules will be laid out in a formal document which may be legally enforced and fines will be charged for firms who break these rules
What is the problem with the cartel?
There is a constant temptation to break the cartel. The more successful the cartel the greater the incentive to break it. It is important for firms to be the first to break it and not the firm who is left to deal with the after effects.
What are the consequences of overt collusion?
-Higher prices for consumers
-Less output in market
-Poor quality products and/or customer service
-Less investment in innovation
What are the ways in which overt collusion often happen?
-Price Fixing
-Setting output quotas limiting supply
-Agreements to block new firms
-Agreements to pay suppliers same price
What is Tacit collusion?
Means there is no formal agreement but closely monitor each other’s behaviour usually following the lead of the largest firm in the industry
What is the most common form of tactic collusion?
Price leadership or price matching. This occurs when firms monitor the price of the largest firm in the industry and then adjust their prices to match. It’s difficult for regulators to prove that collusion has occurred
What is non collusive behaviour?
In oligopolies occurs when firms actively compete to maintain/ increase market share
What theory can be used to examine the best strategy a firm can adopt for each assumption about its rivals?
Game Theory
What is Game Theory?
Mathematical framework which is used by firms to ensure optimal decisions are made in a strategic setting when there is a high level of interdependence. Explores the reactions of one player to changes in strategy by another player.
What are the three elements of any game? (Game Theory)
- Players (Firms)
- Strategies available to players
- Payoffs (outcomes) each player receives for each combo of strategies
What simple model first showed Game Theory?
The prisoners dilemma
What is the Prisoners Dilemma? What does it look like?
Two criminals are caught after a train robbery (Carol + Dough). The prosecutor doesn’t have much evidence. The criminals are guilty but have agreed with each other that they will deny all involvement. The prosecutor wants one or both to confess. Slide 28
When do firms use Game theory?
When making decisions:
-to lower or raise prices
-about advertising and branding initiatives
-about investment in product innovation
-about product bundling
What is Price Competition?
Businesses compete with one another by lowering their prices in order to attract customers.
What three types of price competition will firms in an oligopoly market engage in?
- Price Wars
- Predatory Pricing
- Limit Pricing
What are Price Wars?
Occur when competitors repeatedly lower prices to undercut each other in an attempt to gain increased market share. Happens when firms find difficult to collude
What is Predatory Pricing?
Practice of lowering prices when a new competitor joins the industry in order to drive them out. Prices are often lowered to a point below cost of production and once they have left the market prices are raised again.
Is Predatory Pricing legal? Why?
Predatory Pricing is illegal as its anti competitive
What is limit pricing?
Occurs when firms set a limit on how high the price will go in the industry. Lower price reduces profit and disincentivised other firms from joining the industry. The greater the barriers to entry the higher the limit pricing is likely o be as firms are already disincentivised
What is non-price competition?
Competition not based on price but on branding, product differentiation and marketing
Why do firms engage in non-price competition?
Aim is to increase product differentiation, develop or increase brand loyalty and to increase market share
What are some examples of strategies used in non-price competition?
-Loyalty cards and rewards: encourage repeat purchasing
-Branding: Successful brand increase loyalty
-Packaging
-Celebrity/ Influencer endorsement
-Corporate sponsorship
-After sales service
-Delivery policies
-Product warranties
What type of efficiency will firms in oligopoly market structure be?
It is when a market or economy is in an efficient state, and there is no way to improve the welfare of individuals without hurting someone else. Likely to be dynamically efficient.
Can firms in an oligopoly market structure have access to economies of scale easily?
Yes they will be able to exploit economies of scale lowering prices
