oligopoly (L13) Flashcards
how can you look at how close a particular market is to being a monopoly?
examine the degree of concentration in the market
how is concentration measured
concentration ratio which measures the market share of the largest fixed no of firms in the market (eg 3 firm concentration measures 3 largest)
in what ways can concentration be measured
employment (proportion of workers in the industry) or largest markets, on shares in output or shares in employment
why may measures of shares in output differ to shares in employment?
larger firms may use capital intensive methods so their share of employment would be lower than share of output
cooperative oligopoly leads to..
monopoly end of the spectrum
non-cooperative oligopoly leads to…
competitive end of the spectrum
when is an oligopoly likely to develop
modest economies of scale- not enough for a natural monopoly but large enough to make it hard for too many firms to operate at minimum efficiency
characteristics of oligopoly
small number of large firms
high barriers to entry(patents, control of natural resources, start up costs)
differentiated/homogeneous eg cereal/oil
mutual interdependence(decision of one firm affects another)
what implications does mutual interdependence have for the behavior of oligopolistic firms
strategic behaviour- based on plans accounting rivals possible courses of action to formulate own strategy
conflicting incentives-to collude and compete
what are the conflicting incentives in oligopolys
to collude- agreement to limit competition between them usually by fixing prices to lower quantity produced. Limits comp, reduces uncertainty.
to compete-trying to capture a portion of its rivals market shares and profits
whose work is game theory based on
John F.Nash
what is game theory?
illustrates prisoner’s dilemma- 2 rational decision makers who use strategic behaviour to maximise profit by guessing rivals behaviour may end up collectively worse off (nash equilibrium is the final position)
what does nash equilibrium show?
conflict between pursuit of individual self interest and collective firm interest sometimes
collusive oligopoly
agreement to limit comp, increase monopoly power, increase profit
common forms of collusion
price fixing agreements (holding price constant/raising price by fixed amount/fixing price differences)
cartel
formal agreement to take actions to limit comp and increase profits (open/formal collusion) can be done by limits to output produced, restricting advertising etc, agreeing to set up barriers to entry
collectively behave like a monopoly
example of cartel
OPEC (org of petroleum exporting countries) w 13 oil producing countries eg Iran, tries to periodically raise world price of oil by cutting back total ouput. each member=assigned an output level (quota) that it can produce.
what factors make it difficult for a cartel to be established and maintained?
incentive to cheat cost diff between firms number of firms possibility of price war recessions potential entry into industry lacking dominant firm PRICEND
cost diff between firms
each firm faces different costs and cost curves, firms with higher ac have lower profits and lower ac have higher profits so its hard to agree on common prices, different demand curves bc of market share and product differentiation
incentive to cheat
secretly lower prices for some buyers to increase market share and profit but if they’re discovered, the cartel is in danger of collapsing
number of firms
larger number of firms = harder to agree on price and allocation of output as there are more views and compromise is harder to achieve
possibility of a price war
cheating=retaliatory price cuts=price war= collectively worse off
recessions
sales + profit fall=stronger incentive to lower prices and cheat
potential entry into the industry
profits encourage entry of new firms increasing supply and lower price which lowers the cartels profits, cartels long run survival depends on high barriers to entry
lacking dominant firm
its presence helps reach agreement as the firm assumes leadership position- dominant member of OPEC is Saudi Arabia
tacit collusion
informal, cooperation thats implied by the firms without a formal agreement to coordinate prices, avoid competitive price cutting, limit competition, reduce uncertanties and increase profits
examples of informal collusion
price leadership, dominant firm in the industry sets a price and initiates price changes and the remaining firms become price takers, but they can still compete with non price tactics
prices changes aren’t frequent and are undertaken by the leader when cost changes occur
limit pricing
examples of industries that followed the price leadership model
US steel, Kellog’s
obstacles of sustained price leadership
cost differences makes it hard to follow the leader- if the leader initiates a price increase and it isn’t followed, it would risk losing market share and sales
incentive to cheat
profit attracts new entrants which cuts into market shares and profits
limit pricing
firms informally agree to set a price lower than the profit maximising price to discourage new firms entering the industry which would mean they sacrifice some of their profits
