Oligopoly and concentrated markets 2

Question 1

Non- price competition

Answer 1

Firms may tacitly agree not to indulge in aggressive price competition as a means of gaining extra profits or market share at expense of other, as they realise it is self defeating for all firms involved.

Question 2

Forms of non-price competition

Answer 2

1: Quality competition eg. after-sale service, warranties
2: Use of persuasive advertising, product differentiation, brand packaging, fashion, style and design
3: Offering complementary goods and service eg. free home delivery
4: Store layout

Question 3

Barriers to entry

Answer 3

Protect firms position

Question 4

Natural barriers to entry

Answer 4

1: Economies of sale: established firms more productively efficient and lower LRAC than new entrants
2: Indivisibilities - prevent certain goods being produced in plants below a certain size eg. metal smelting

Question 5

Artificially barriers to entry

Answer 5

• Strategic barriers - deliberate actionably incumbent firms to prevent new firms from entering the market
  1: Patents
  2: Limit pricing and predatory pricing ( large firm can often get away with predatory pricing as difficult to prove that it has taken place).

Question 6

Cartel

Answer 6

A collusive agreement by firms, usually to fix prices. Sometime output may also be fixed.

Question 7

Collusion

Answer 7

Restrictive practices = Collusion.

Collusive corporative behaviour enables firms to reduce uncertainty they face in imperfectly competitive markets.

Some forms of collusion, eg. joint product development or ensuring industry safety standards are in the publics best interests.

Question 8

Tacit collusion

Answer 8

Unwritten/spoken

eg. price leaders in some industries

Question 9

Overt/formal collusion

Answer 9

Explicit eg. meetings, emails, phone calls

Question 10

Other types of restrictive practices

Answer 10

Price fixing
Information sharing
Agreeing restrictive practices such as ‘offering no guarantees’

Question 11

Cartels enable…

Answer 11

• enable inefficient businesses to say in practice, where as in competitive markets the firm would have to reduce costs or go out of business.
• other members of cartel enjoy supernormal profit.
• cartels display disadvantages of a monopoly = high prices and restriction of choice. However this is without the benefits that monopoly can sometimes bring, eg. EoS and improvements in dynamic efficiency.

Question 12

Aims of price fixing

Answer 12

• attempt by firms to recognise their interdependence and act together rather than compete
• a move towards joint profit maximisation/monopoly profits
• reduces uncertainty between firms

Question 13

Joint profit maximisation

Answer 13

This illustrates how firms can make more profit by colluding and restricting competition than by action independently.

Question 14

Economic cost of collusion: 1

Answer 14

Damages consumer welfare

• Higher prices/lost consumer surplus
• Hits lower income families

EV: Economic cost depends on the market in which collusion occurs eg. high prices in cigarettes (demerit goods) may not be as bad as high prices in books merit goods)

Question 15

Economic cost of collusion: 2

Answer 15

Absence of competition hits efficiency.

• C-inefficiences/higher costs
• Less incentive to innovate (dynamic inefficiency)

Question 16

Economic cost of collusion: 3

Answer 16

Reinforces monopoly power
- harder for new businesses to enter

EV: Effects contestability

Question 17

Why might cartels break down? More companies

Answer 17

• More companies in the industry, the harder it is to form a cartel and enforce it. Difficult to successfully organise.

Question 18

Why might cartels break down? Barriers to entry

Answer 18

The weaker the barriers to entry are, the harder it is to ensure cartel.
If new firms enter the industry, they may establish a new baseline price and eliminate collusion.

Question 19

Why might cartels break down? Cheat

Answer 19

Strong incentive to cheat within a cartel on collusion agreements due to potential considerably large short term gains, and a firms output/prices cannot easily be checked. However, this may trigger a price war.

Question 20

Why might cartels break down? Legislation

Answer 20

Government legislation = CMA Competition and Markets Authority

Question 21

Why might cartels break down? Elasticity

Answer 21

If demand is not elastic enough (PED/YED) = too variable

Question 22

Collusion EV

Answer 22

Collusion is easier if the g/s is homogenous. Then the industry’s cost of production change in the same way for all firms. So prices may move together because of this, rather than because of collusion. EV on whether High prices is definitely evidence of collusion.

Question 23

When can collusion be good?

Answer 23

• Countering monopsony power
• To ensure high industry standards
• Stability in prices
• Higher supernormal profits can be used productively on R&D and dynamic efficiency

Question 24

Monopsony

Answer 24

Market position where there is only one buyer.

Question 25

Game theory

Answer 25

Study of how people behave in strategic situations (ie. when they have to consider the effect of other people’s responses to their own actions). In an oligopoly, each company knows that its profits depend on actions of other firms. This gives rise to the prisoners dilemma.

Question 26

Prisoners dilemma

Answer 26

Both players select their own dominant strategies for shortsighted personal gain. Eventually they both reach an equilibrium where they are worse off than they would have been, if they could both agree to select an alternative (non-dominant) strategy.

*Whilst both firms want to charge high prices, there is alway the incentive to undercut the other to steal market share, but this leads to a mutually destructive price war.”

Despite colluding, there is always an incentive to cheat and undermine the cartel.

Question 27

Nash equilibrium

Answer 27

Exists if no players change their strategy, despite knowing the actions of their opponents.

Question 28

Why do barriers to exit matter? Hit & Run Competition

Answer 28

• Enter market (no. barrier to entry)
• supernormal profit
• more firms enter market
• supply shifts out
• undercut monopolist, take away the monopolists market share
• monopolist reacts and employs predatory pricing
• new entrant cannot compete at this lower price
• leaves market having made SR supernormal profit
  HIT & RUN COMPETITION = this forces the monopolist to reduce prices and make less profit as predatory pricing.

Therefore barriers to exit prevent hit and run competition as costs of leaving the market may be higher than short run supernormal profits and the potential entrants have perfect information, therefore have no incentive to engage in hit and run competition.