Oligopoly market structure Flashcards
define oligopoly
an industry dominated by a few large firms
e.g. Car industry – economies of scale have caused mergers so big multinationals dominate the market. The biggest car firms include Toyota, Hyundai, Ford, General Motors, VW or supermarket industry in UK
characteristics of oligopolies
- five-firm concentration ratio of more than 50%
- differentiated goods= price makers
- high barriers to entry and exit
= high start up costs, EoS costs, sunk costs and brand loyalty - interdependent= firms make choices based of actions or reactions of other firms= causes price rigidity
= think about rival firms before they make their own decisions - non-price competition e.g quality, ads, brandy loyalty etc etc
- profit max not always main objective= market share etc
- selective price wars to increase market share
= will do anything to max market share= profit max, sales max etc
describe kinked demand curve diagram
- @P1, there are differing elasticities of demand= above P1 there is price elastic demand curve, below is price inelastic demand curve
= makes no sense for firm to change their price - if they increase it, Q will fall proportionately more than the increase in price
= due to interdependence= other firms won’t follow price rise= there will stay @ P1 in order to max market share= will undercut firm w higher prices
= decrease market share and total revenue for firm - if firms decrease price, other firms will follow in order to protect their market share= lead to price war
= total revenue will decrease as demand is price inelastic= no change in net market share over time= no in best interest of firm - suggests prices will be fairly stable= little incentive for firms to change prices= compete using non-price comp methods
- as long as costs change within gap, profit maximising oligopolist producing where MC=MR, will always charge a price of P1
- may be price competition as firms could reduce price to max market share and outcompete rivals
- will be non-price competition due to price rigidity
Evaluation of kinked demand curve
- In the real world, prices do change= price wars of supermarkets like Waitrose vs Aldi
- Firms may not seek to max profits= prefer to increase market share= willing to cut prices, even w inelastic demand
- Some firms may have very strong brand loyalty and be able to increase the price without demand being very price elastic
- Model doesn’t suggest how prices were arrived at in the first place
- can be temptation to collude= firms always have to compare to actions and reactions of rivals= can be frustrating= incentive to break interdependence and collude= decrease rivals and act as monopoly with fixed prices that make very high profit
define collusive
when firms coordinate their actions on price levels in order to max profits
= leads to high consumer surplus, high prices and high profits for firms colluding
= allow oligopolists to act as monopolists to max joint profits
describe game theory
looks at the decisions of firms based on the uncertainty of how other firms will react
- if a firm agrees to collude and set low output – it relies on the other firm sticking to the collusive agreement
- if the firm sets the high price= other firm betrays its agreement (setting low price)= firm will be worse off
- if they are colluding there is an incentive for one of the firms to exceed quota and increase output
describe causes of competitive oligopoly
- if there are large number of firms= less concentrated oligopoly= harder to reach collusion agreement= one firms has cost adv
- homogenous goods= firms don’t have price making power of fixed prices
adv of comp oligopoly
- allocative efficiency
- low x-inefficiency
disadvantage of comp oligopoly
- dynamic efficiency might be limited due to the lack of
supernormal profits - Since firms are small, there are few or no economies of scale
causes of oligopoly collusion
- small no. firms= easy to form agreements
- similar costs of firms
- high barriers to entry= won’t attract new firms= benefits of LR supernormal profit
- consumer loyalty won’t change
define price rigidity
- happens when firms set similar prices and have little incentive to change them even when there’s a change in COP
describe cartel in oligopoly
- groups of 2 or more firms who agreed to control prices, limit output or prevent entrance of new firms into market
= e.g. OPEC fixed their output of oil= controlled 70% oil supply in world= decrease uncertainty for firms that would exist wo cartel - can increase prices for consumers or restrict output in order to divide market up into areas for each firms= won’t compete w each other
describe price leadership
- when 1 firm changes prices and others follow otherwise they risk losing market share= leads to price stability
describe price wars
- type of price competition where firms constantly cutting prices below rivals to max market share= rivals then decrease prices aswell e.g. supermarkets
describe non-price comp
- areas like brand loyalty increase price inelastic demand= consumers loyal to brand not price
- may improve customer service, quality, advertising and marketing etc in order to attract new customers and improve brand recognition
BUT - no guarantee of effect= high risk of sunk costs
define sunk costs
expenses that have already been incurred and which are unrecoverable
effects of collusion
can increase prices to max profit of colluding firms
= leads to increased consumer surplus
= allow oligopolists to act as monopsonies and max joint profits
define consumer surplus
when the price that consumers pay for a product or service is less than the price they’re willing to pay
define overt collusion
formal (illegal) agreement between firms
= can be form of price fixing to max joint profits, decrease costs of comp by preventing wasteful sunk costs like advertising
= decrease uncertainty
define tactic collusion
- no formal agreement but collusion is implied
= e.g. supermarkets competing in price wars
= Waitrose profits decreased by 24% in 2015 due to low prices
diff between cooperation and collusion
legal agreement between 2 firms who work for mutual benefit
vs
secret or illegal agreements between firms to engage in anti-comp behaviour like price fixing or market allocation
= done to gain unfair adv over rivals or to increase profits @ expense of consumer
effects of cooperation
- reach specific goals like efficiency, low costs or share scarce resources etc
= create primary focus on mutual benefit to reach common objectives while being legal - can develop strategic alliances to develop new tech or enter new markets
e.g. airlines cooperate through code-sharing agreements that allow passengers to book flights on partner airlines
adv collusive oligopoly
- increase supernormal profit= increase innovation and dynamic efficiency gains
- EoS benefits
disadv collusive oligopoly
- allocative inefficiency
- x-inefficiency
- productive inefficiency
