Oligopoly Flashcards
So, in summary what are the key features of oligopolistic markets?
There market is dominated by a few large sellers!
High barriers to entry/exit: so it’s hard for new firms to enter the market.
is differentiated goods. All goods must be similar but slightly different.
And 4 is interdependence: one firm’s actions will directly affect another firm.
Oligopoly
The market is dominated by a few large sellers
High barriers to entry/exit
Differentiated goods
Interdependence between firms
Because their demand is inelastic, following a 75% increase in price, quantity demanded would:
decrease by less than 75%
When demand is inelastic, an increase in price will:
increase total revenue.
Why are Pepsi and Coke different fizzy drinks both priced at 60p?
The fizzy drinks market is oligopolistic so firms are interdependent: one firm’s action will directly affect another firm.
If Pepsi-so undercuts Coca Cola with a lower price, a price war will break out and they’ll both compete away their profits.
If Pepsi-co increases its price, it will lose its consumers to Coca Cola.
So firms have no reason to change their price from 60p
And finally, assuming demand is inelastic, what will happen if both firms choose low price?
quantity will increase by a smaller %, so total revenue will decrease
So firms want to avoid price wars! How do they avoid them?
Firms can agree to collude and fix their prices at a high price.
But why? Why would Virgin Atlantic blow the whistle and confess to the CMA?
By whistle-blowing, Virgin Atlantic was offered immunity (protection) from the CMA’s fines.
So, in summary, overt collusion is when:
Overt collusion is when there’s a formal agreement between firms to collude.
Peter sees that Mandeep sells their chicken for 50p a wing. So Peter will also sell his chicken at 50p a wing - why?
If Peter sets a lower price (e.g. 40p), Mandeep will retaliate with an even lower price (e.g. 35p), and a price war will soon break out. Prices will be driven so low, neither firm will be able to make a profit. So Peter won’t want to decrease price.
And if instead Peter sets a higher price (e.g. 60p), he would would lose loads of consumers to Mandeep. So Peter won’t want to increase price either.
So Peter will end up selling at 50p, too - just like Mandeep!
tacit collusion
Tacit collusion is when there’s an unspoken agreement between firms to collude.
Collusion
When two firms work together to limit competition (e.g. price-fixing).
Overt collusion
When there’s a formal agreement between firms to limit competition .
E.g. a phone call/contract/handshake between firms.
Tacit collusion
When there’s an unspoken agreement between firms to limit competition.
What forms of Collusion is illegal?
Both overt and tacit collusion are illegal!
Price wars
Price wars are when firms try to undercut each other with lower prices to steal the other firms’ consumers.
Where is a firm’s short run shutdown point:
Where AVC = AR
How might a firm compete on price?
- Price wars
- Predatory pricing
- Limit pricing
Price wars
Price wars: when firms try to undercut each other with lower prices to steal the other firms’ consumers.
Price wars can be very dangerous! As firms cut their prices lower and lower, any supernormal profit will be competed away.
E.g. baked bean wars, when supermarkets undercut each other and drove the price of baked beans down to just 3p
Predatory pricing
- Predatory pricing: when a firm aggressively cuts its prices below AVC to force out competitors from the market.
When a firm aggressively cuts its prices below AVC to force out competitors from the market.
Short run: firm incurs a loss
Long run: firm forces out its competitors, so they can take over the market.
Limit pricing
When an incumbent firm uses its economies of scale to set a price low enough to limit new firms from entering.
Small new firms, without economies of scale, won’t be able to compete so they’ll stay out of the market.
Limit pricing is a barrier to entry.
non-price competition
When firms compete without changing price, e.g:
Advertising
Loyalty cards
Branding
Quality
What assumptions do economists make to model monopolies?
3 assumptions:
Only one firm in the market
They want to maximise profit
There are high barriers to entry
Why are sunk costs a barrier to entry?
Sunk costs are costs that cannot be recovered (e.g. advertising).
High sunk costs are a barrier to entry: they deter new firms from entering because firms know that if they fail, they won’t be able to recover any of their sunk costs.
