Oligopoly to Monopoly: How to measure, Adv, Disadv, Price Discrimination, Collusion, Game theory, Kinked Demand Curve and Natural Monopoly Flashcards
What is an Oligopoly? Give examples
A small number of firms dominate the market Eg: cars, General Motors, Ford, Toyota - Phones, Samsung and apple
How would you measure if a market is an Oligopoly?
Concentration ratios: Add up the market shares of the biggest firms in the market. Anything above 40% is considered an Oligopoly but this can vary. The closer the market shares of the companies are the more competitive the Oligopoly is likely to be.
What are the characteristics of an Oligopoly? (7)
There’s no single theory of Oligopoly, instead most tend to feature the following main characteristics:
- Few large firms dominate the market
- Very big firms so very high barriers to entry, behavioural barriers, high entry cost
- Firms tend to be earning supernormal profits as new firms struggle to enter and take them away, the market isn’t very contestable
- Firms under Oligopoly are very interdependent and must always take into account what the competitors actions may be in response to what they do
- High levels of non-price competition
- Most of the businesses are large enough to benefit from economies of scale
- Collusion is most likely to be seen in an Oligopoly due to there being few large firms in the market, this is illegal.
What is non-price competition (give an example) and why do firms in Oligopoly choose this?
Non-price competition is where businesses compete in ways that don’t involve reducing price
For example: leading companies in mobile phone markets compete by the best tech not by price.
Firms in Oligopoly avoid price competition to get more profits and avoid a price war. This can be explained by game theory and the kinked demand curve.
What is Informal collusion?
When there is no agreement between the firms but they know how to act from past experience.
E.g: Price leadership- The largest most powerful business in the market sets the price, the other businesses follow and set the same price.
There are two reasons why they’re willing to do that:
- They can charge a higher price so it’s easier to earn supernormal profits
- They’re reluctant to challenge the price because they suspect that it may lead to a price war, they would lose out and possibly be forced out of the market.
What is formal collusion?
Nothing is written down, but they all agree verbally to set the same prices.
When businesses do this it’s called a cartel.
What are the laws and risks of collusion?
Any type of collusion is illegal, if caught a business could be fined of up to 10% of their revenue
Collusion is very risky because if any of the firms involved goes to the government and tells them what’s happening then that firm won’t be fined (whistle blowing).
What are the 2 main advantages of an Oligopoly?
- Businesses should be big enough to benefit from economies of scale, this will reduce their costs and if the market is competitive enough it will reduce the price for consumers
- Firms in Oligopoly tend to feature high levels of dynamic efficiency, this is the main way they compete because customers expect the product to keep getting better and it helps to avoid a price war; furthermore they can easily afford it as they’re making super-normal profits.
What are the 5 main disadvantages of Oligopoly
- Due to the downward sloping demand curve these firms face it’s impossible to feature allocative efficiency; average revenue will always be higher than marginal revenue
- Low competitive pressure may result in less choice for consumers
- Unlikely to feature productive efficiency for the same reasons
- Firms are more likely to collude and form cartels in Oligopoly
- A Grade point: Under Oligopoly we expect firms to be spending large amounts of money on advertising, inreasing costs, this may lead to higher prices for consumers. However if the advertising helps them to attract more customers they will have an increased market share, they may benefit from more economies of scale and therefore costs and prices might lower. BUT too much advertising will tend to influence what their customers do, it might encourage them to be loyal to their product. If that is true then consumers are no longer in full control of what they do and therefore are no longer in consumer sovereignty.
What is the kinked demand curve?
A model used to explain why Oligopolies are reluctant to compete in terms of price
Explain the shape of the kinked demand curve
Reducing price:
Firms in Oligopoly suspect that if they tried to sell a lot more phones by reducing their price, all of their rivals will likely do the same, this will mean they wont get many more customers, making their demand below P very price inelastic; therefore there is no incentive to reduce price.
Increasing Price:
If they increase their price, rivals are unlikely to do anything and so rivals products will now be cheaper than the other firm’s which will result in a loss of customers, this is why the kinked demand curve is shaped elastically above the equilibium price (P).
What is the nash equilibrium? (draw it)
Used to explain why businesses under Oligopoy don’t like competing in terms of price. It assumes there are just 2 firms and consists of a matrix to show why businesses avoid competing in terms of price.
The danger is that once the firms move out of box one they’ll both have to reduce their prices and will very quickly end up in box 4
Detailed description of each box:
Box 1: Perfect position for the firms as they’re both charging a high price so they’re both making large profits.
Box 2: Firm A has chosen to reduce it’s price but firm B has kept it’s price the same, this means thatfirm A will get more customers and market share; but the opposite will happen for firm B.
- *Box 3:** Firm A is charging a high price and B a low price, this will be the opposite of Box 2
- *Box 4:** IN box 4 both firms are earning low profts in equilibrium.
Why might a price war occur? (3 reasons explained)
- Economy goes into recession- Businesses have to reduce prices as consumers have less income
- New business tries to enter the market- Other firms retaliate by reducing their prices to force them out of the market
- One business feels they’ve become so powerful that theireconomies of scale are much greater so they feel they can take the other businesses on, charge lower prices and icnrease their market share in the long term even if it means decreasing profits in the short run.
What are profits levels for firms in Oligopoly in the short and long run, and why?
Profits are supernormal for both due to very high barriers to entry in the short and long run.
New firms struggle to enter and take them away which makes the market quite incontestable.
(Ask mike to clarify this)
What is a natural monopoly and why do they occur?
When it’s not efficient to have competition in a market, it’s better as a monopoly.
If you did have competition in the market those businesses would not benefit from as many economies of scale, they would have to pay for all the same capital equipment, which will largely be a waste of resources and because of that the market will become less efficient.