Oligopoly and concentrated markets 2 Flashcards
Non- price competition
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.
Forms of non-price competition
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
Barriers to entry
Protect firms position
Natural barriers to entry
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
Artificially barriers to entry
- 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).
Cartel
A collusive agreement by firms, usually to fix prices. Sometime output may also be fixed.
Collusion
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.
Tacit collusion
Unwritten/spoken
eg. price leaders in some industries
Overt/formal collusion
Explicit eg. meetings, emails, phone calls
Other types of restrictive practices
Price fixing
Information sharing
Agreeing restrictive practices such as ‘offering no guarantees’
Cartels enable…
- 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.
Aims of price fixing
- 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
Joint profit maximisation
This illustrates how firms can make more profit by colluding and restricting competition than by action independently.
Economic cost of collusion: 1
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)
Economic cost of collusion: 2
Absence of competition hits efficiency.
- C-inefficiences/higher costs
- Less incentive to innovate (dynamic inefficiency)
Economic cost of collusion: 3
Reinforces monopoly power
- harder for new businesses to enter
EV: Effects contestability
Why might cartels break down? More companies
- More companies in the industry, the harder it is to form a cartel and enforce it. Difficult to successfully organise.
Why might cartels break down? Barriers to entry
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.
Why might cartels break down? Cheat
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.
Why might cartels break down? Legislation
Government legislation = CMA Competition and Markets Authority
Why might cartels break down? Elasticity
If demand is not elastic enough (PED/YED) = too variable
Collusion EV
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.
When can collusion be good?
- Countering monopsony power
- To ensure high industry standards
- Stability in prices
- Higher supernormal profits can be used productively on R&D and dynamic efficiency
Monopsony
Market position where there is only one buyer.
Game theory
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.
Prisoners dilemma
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.
Nash equilibrium
Exists if no players change their strategy, despite knowing the actions of their opponents.
Why do barriers to exit matter? Hit & Run Competition
- 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.
