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Economics Micro - No Diagrams > Theme 3 CC3 - Oligopoly (P2), objectives, growth/rationalisation > Flashcards

Theme 3 CC3 - Oligopoly (P2), objectives, growth/rationalisation Flashcards

1
Q

Define Market concentration

A

The degree to which the output of an industry is dominated by its largest producers

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2
Q

Explain difference between concentrated and diluted market

A

Highly concentrated is if 5 firms hold 50% or more meaning it is dominated by big firms whereas diluted is if there are less dominant firms and more shared out between firms.

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3
Q

Define market share

A

The proportion of sales revenue in a market taken by a firm or a group of firms

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4
Q

What is the concentration ratio? How is it worked out?

A

The combined market share of the n largest firms in the industry
(Add up the n largest firms shares - ignore other)

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5
Q

Define oligopoly and give example

A

A market where a small number of interdependent firms compete with each other e.g. supermarkets

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6
Q

Give characteristics of oligopoly

A
  1. High BTN/BTX
  2. Dominated by few firms, alongside large number of small firms e.g. high concentration ratio
  3. Firms are interdependent - when actions of one firm have an impact on other firms e.g. decisions on price/output and other competitive activities have immediate effect on competitors.
  4. Product differentiation - Aspects of good or service which distinguish products from another.
    - 4 P’s (Price, place, product, promotion)
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7
Q

What is the kinked demand curve theory?

A
  • the theory that oligopolists face a demand curve that is kinked at the current price, demand being significantly more elastic above the current price than below. - Therefore creates price stability.
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8
Q

Explain price rigidity using kinked demand curve

A

AR curve: -No point in raising price above p1 as demand falls significantly (price elastic), other firms will not react since lower price is more competitive. Original firm will be pricing itself out of the market.
-No point in cutting price below P1 as competitiors will react seeing it as threatening move and reduce their prices to prevent erosion of their market share. All revenues will fall as price inelastic (demand will only slightly increase for a larger price drop).

MC/MR curve: Kink in demand means a rise or fall in costs is likely to have no impact on price and output. Therefore, prices in oligopolistic markets tend to be stable.

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9
Q

What are the problems of the kinked demand curve?

A
  • Initial price/output not explained (no intersect)
  • No reliable empirical evidence to support curve (only theoretical)
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10
Q

Define collusion

A
  • Collective agreements between producers which restrict competition - this can be overt (open or formal) or tacit (silent or informal).
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11
Q

Give 3 reasons for collusive behaviour

A
  1. Joint profit maximisation
  2. Prevent price and revenue instability and hence profit uncertainty
  3. Cut costs of competition e.g. marketing wars
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12
Q

Give 2 reasons for non-collusive

A
  1. Desire to increase market share and achieve market dominance
  2. Stringent regulatory regime acts as a deterrent to collude (as illegal)
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13
Q

What is the difference between overt and tacit collusion?

A
  • Overt collusion is when firms make agreements among themselves to restrict comp i.e. communication has taken place
  • Tacit collusion is when firms co-operate without any formal agreement or even without explicit communication between firms. e.g. price leadership
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14
Q

What is price leadership?

A

When one firm, the price leader, sets its own prices and other firms set their prices in relation to the price leader. e.g. firms who market to consumers they are never undersold is form of tacit collusion. However, regulators may choose to overlook as it results in lower prices for consumers.

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15
Q

What is a cartel? Give example

A

an agreement between firms on price and output with the intention of maximising their joint profits.

OPEC - International (so legal) organisation that regulates price of oil in order to set price on world market, reduces output to achieve higher prices and therefore maximise LT revenues from sale of oil.

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16
Q

Give 5 conditions required for an effective cartel

A
  1. An agreement must be reached - in oligopoly if large amount of firms, one key ppt may refuse to collude
  2. Cheating must be prevented to prevent falling market price and loss of SNP
  3. Potential comp must be restricted by increasing BTN to protect themselves in LR
  4. Easier in stable industries where no firm has previously gained advantage from aggressing competitive strategies.
  5. Demand is fairly price inelastic - Demand will not be as responsive to price changes
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17
Q

Give 3 advantages of collusion

A
  • Higher producer surplus.
    Supernormal profits can be reinvested in R&D →dynamic efficiency =ensures long-term security of supply
  • Price stability in volatile commodities markets (e.g. crude oil)
  • Shareholders benefit from higher profits through enhanced dividends and bolstered share price
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18
Q

Give 3 disadvantages of collusion

A
  • Loss of consumer welfare –higher prices, lower output, allocative inefficiency
  • Less competition may lead to inefficiency
  • depends on Extent to which the five conditions on p14 hold
  • Overt or tacit? – tacit hard to prove
  • Illegal and may lead to fines - regulators
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19
Q

Define game theory

A

the analysis of situations in which players are interdependent and have incomplete information on the others intentions.

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20
Q

What is a payoff matrix?

A

Model of game theory between two interdependent firms making simultaneous decisions about pricing.

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21
Q

What is Nash equilibrium?

A

The most stable, low risk outcome, delivered by the dominant strategy.

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22
Q

Explain first move advantage

A

a form of competitive advantage that a company earns by being the first to enter a market.

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23
Q

Give 2 advantages of first mover advantage

A
  • Brand loyalty (e.g. Dyson – despite cyclone tech patent expiring)
  • Premium pricing – monopoly power (espec. for 20 yr patent duration)
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24
Q

Give 2 disadvantages of first mover advantage

A
  • Costs (R+D, etc) – starting from scratch
  • Second mover can learn from first mover’s mistakes
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25
Q

Give 3 strengths of game theory

A
  • Helps us to understand the benefits of collusion
  • Straight-forward tool of analysis
  • Based on idea of interdependence
  • Shows how danger of cheating is likely so that collusion might break down in the long run
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26
Q

Give 3 limitations of game theory

A
  • Assumes players know pay-offs (unrealistic in new market)
  • Assumes simultaneous decisions
    *Assumes two firms only
  • Assumes two options only
  • Assumes firms always behave rationally
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27
Q

Name 4 pricing strategies

A
  1. Price wars - where several firms in a market repeatedly lower their prices to outcompete other firms by gaining or defending market share. e.g. 2002 UK tabloid newspaper market - mirror (32p to 20p) vs the sun (30p to 20p), prices kept dropping.
  2. Predatory pricing - where a firm sets price below AVC in attempt to force out rivals from market and achieve market dominance (illegal in UK)
  3. Limit pricing - when a firm sets low price to deter new entrants from coming into market (^BTN and exploiting EOS) instead of maximising SR profit.
  4. Price discrimination
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28
Q

Give 4 non-pricing strategies

A

BNCPM

  1. Brand loyalty - name/design/symbols which distinguishes products from other similar products. Advertising to increase publicity, possibly including celebrity endorsement
  2. New product development/production methods - investment in R&D to improve product technology/quality. Improve efficiency and long-run cost savings.
  3. Product differentiation - quality, ingredients/flavour, additional services/loyalty cards. Product, place, promotion
  4. Collusion
  5. Mergers/takeovers
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29
Q

Define contestable markets -

A

A market with low barriers to entry & exit where threat of competition exists

30
Q

Give 5 characteristics of contestable markets

A
  • Freedom of entry
  • Freedom of exit (Low sunk costs)
  • Firms compete with each other and don’t collude
  • Firms have perfect knowledge
  • No significant brand loyalty
31
Q

Explain predictions of model in SR in terms of profit and entrants

A
  • SNP can be made in SR
  • Incentivises new entrants to enter market as long as sunk costs are low.
  • ‘Hit and run competition’ occurs when new firms quickly enter an industry to take SNP then leave once profits are exhausted. Leaving only normal profits made in LR
  • Threat of new entrants encourages firms to keep prices down (to maintain market share) and produce efficiently as possible (EOS, tech developments, X-efficiency)
32
Q

Explain efficiencies of contestable markets

A
  • LR firms will move towards operating at min of AC curve where MC=AC therefore are productively efficient.
  • firms move towards Normal profits where AR=AC in LR (no incentive to leave), therefore firms are allocatively efficient.
  • Demonstrates limit pricing at AE/PE point rather than at profit max.
33
Q

Give 3 evaluation points of contestable markets

A
  • Wasteful rebranding
  • ‘Corner cutting’ with lower price at expense of quality
  • Lack of LR SNP and therefore no dynamic efficiency
  • Harder to sell shares as potential shareholders anticipate poor dividends
  • small Firms that leave industry, resulting in job losses, but they can still join large firms in industry.
34
Q

What are the implications of contestable markets for the behaviour of firms?
- How does comp effect efficiency?
- How can firms avoid hit and run tactics

A
  • Potential threat of comp more important for econ efficiency than actual comp
  • Therefore all markets can be efficient as long as they are in contestable markets.
  • Avoid hit and run by limit pricing to normal profit (AR=AC) instead of profit max. Incumbent firms forced to do this in comp to maintain market share and therefore must be satisfied with normal profits due to threat of hit and run.
35
Q

What is the influence of contestable markets on govt policy?

A
  • Monopoly power previously defined by no. of firms and concentration ratios. Controlled by regulation from govt
  • Contestable market theory effects monopoly through free market approach, if they feel threat, reduce prices etc meaning govts/regulators do less causing deregulation due to self-regulation.
  • Limit pricing (naturally occuring) improves efficiency, lowers costs/prices therefore less need for regulation
36
Q

Advantages of Contestable markets

A
  • Efficiencies: Allocatively efficient, productively efficient and X-efficient
  • Therefore lower consumer prices, greater output, more jobs created
  • Self regulating - less govt intervention
  • Low BTN & BTX for new firms
37
Q

Define stakeholders

A
  • Groups who have an interest in the activity and performance outcomes of a business.
38
Q

What does the objective of the firm depend on?

A

Relative influence and interest of various stakeholder groups.
- Dominant group can give greater emphasis to their objectives

39
Q

Give 7 possible business objectives (Main 4+3)

A
  1. Profit max - MC=MR
  2. Revenue max increased output for market share MR=0
  3. Sales max ‘by volume’ - AC=AR may be used to gain market share or drive out rival to max LR profit. (Limit pricing)
  4. Profit satisficing - Businesses make enough profits to keep shareholders happy. Once satisfactory profits made, managers free to maximise own rewards from company.
  5. Allocative efficiency - Govts may seek to ensure firms operate at AE point: AR=MC. May be imposed if state owned or due to regulation
  6. Cost minimisation - Firms may wish to operate at productively efficient point MC=AC (Min). Not dependent on revenue as profit max is.
  7. Long run profit maximising - Short run objective may be to increase market share which leads to higher profits over time. Firms keep stable prices using cost-plus pricing.
40
Q

Define public sector organisations and give main objective

A
  • Organisations owned and controlled by the state e.g. NHS
  • Main objective is to provide a service rather than make a profit
41
Q

Define private sector organisations and give main objective

A

Organisations owned by individuals or groups of individuals e.g. british airways/BT
- Main objective is to make a profit

42
Q

Explain divorce of ownership from control

A
  • Shareholders (known as the principals) in a plc cannot exercise day-to-day control over decisions of managers, many are ‘passive’.
  • Directors (the agents) are appointed to run the company and take most big strategic decisions, but may have different objectives to owners.
43
Q

Define the principle-agent problem

A

A problem arising from the conflict between the objectives of the principals (individuals directly affected by the decision) and the agents (who take decisions on principals’ behalf).
- Best interest of managers may not be best interests of shareholders (asymmetric info).

44
Q

What is the distinction between profit and not-for-profit organisations?

A
  • A profit organisation aims to maximise the financial benefit of its shareholders and owners. The goal of the organisation is to earn maximum profits.
  • A not-for-profit organisation has a goal which aims to maximise social welfare. They can make profits, but they cannot be used for anything apart from this goal and the operation of the organisation. e.g. charities
45
Q

Give 2 ways firms can grow?

A
  • Organic (or internal) growth -
  • External growth
46
Q

What is organic growth? Give example

A

Occurs when a firm increases its size through investment in capital equipment or ^labour force

-E.g. lego introduced new products, such as lego friends, board games, computer games and films

47
Q

What is external growth? Give exmamples

A
  • Growth through merger or takeover
    -E.g. Merger= Amazon merger with Whole Foods. Amazon has knowledge and expertise in online shopping. Whole Foods is a major food retailer. It is hoped the merger will enable Whole Foods to benefit from Amazon’s existing infrastructure and online delivery.
    Takeover= Facebook acquired whatsapp, elon musk acquired twitter
48
Q

What is the difference between a merger and a takeover?

A

Merger= the integration of two or more firms maintaining shared ownership and control.
Takeover= the acquisition of one firm by another where control passes to the acquiror.

49
Q

What are the 4 types of integration?

A
  1. Horizontal
    2,3. Vertical:
    a.Forward
    b. Backward
    4 Conglomerate
50
Q

Explain horizontal integration

A

the joining of two firms in the same industry at the same stage of production

51
Q

Explain vertical integration and the types within

A
  • The joining of two firms at different production stages in the same industry:
    -Forward (Downstream )= Involves a firm buying another further down supply chain towards consumer of a good
    -Backward (Upstream )= Involves a firm buying another back up the supply chain towards supplier of a good.
52
Q

Explain conglomerate integration

A

A merger between two firms producing unrelated products e.g. amazon/whole foods

53
Q

What are the advantages and disadvantages of organic growth?

A

ADV:
+ Low risk
+ Inexpensive
+ No shift in culture

DISADV:
-Slow
-Short term profit motivated shareholders may be unhappy

54
Q

What are the advantages and disadvantages of Horizontal integration?

A

+ Increased market share, therefore exploit EOS
+ Higher barries to entry, less comp, greater SNP, can achieve dynamic efficiency.

-May trigger investigation by CMA
-Cultural clash
-Diseconomies of scale

55
Q

What are the advantage and disadvantages of Forward vertical integration?

A

+ Consistency in product distribution ensured

-Lack of innovation
-Cost

56
Q

What are the advantages and disadvantages of Backward vertical integration?

A

+ Greater certainty wrt suppliers
+ Buy at cost price rather than at market rate

  • May trigger regulation review
57
Q

What are the advantages and disadvantages of conglomerate integration?

A

+Risk diversification
+ Improve brand image

  • Lose core focus, dilutes brand
  • Costly
  • Risky - unknown business model
58
Q

What are the 4 constraints on business growth?

A
  1. Size of market
  2. Access to finance
  3. Owner objectives
  4. Regulation
59
Q

Explain size of the market as a constraint on business growth?

A

Businesses may operate in small or niche markets, meaning that the demand for their goods/services will be limited. As a result of this, there is little room for the business to expand and therefore there is less chance of them experiencing economies of scale.

  • A small market might have limited opportunites for expansion, since firms can only access a limited consumer market and there might be limited opportunities for innovation.
60
Q

Explain Access to finance as a constraint on business growth?

A

Small firms less able to get access to finance. Banks have become more risk averse since financial crisis. Therefore, many small firms cannot invest, grow and innovate as easily as large firms.

61
Q

Explain Owner objectives as a constraint on business growth?

A

Some owners may not want their business to grow any further as they are happy with their current profits and do not want the extra risk or work that comes with growth.

62
Q

Explain Regulation as a constraint on business growth?

A

Excessive regulation can limit output of a business. E.g. taxes such as corp tax might discourage firms earning profit over a certain level. Also mergers which leads to a market share of >25% must be reported to CMA and could be prevented.

63
Q

Define niche market

A

A narrowly defined group of potential customers

64
Q

Give 3 benefits of remaining a SME

A
  • High quality goods, high margin and more insulated from economic downturn; customer loyalty.
  • High BTN= SNP=Dynamic efficiency
65
Q

Evaluate remaining a SME

A
  • Less access to finance
  • More difficult to employ skilled labour as drawn by popular sectors e.g. finance/city work
  • Cheaper high quality imports1
66
Q

Why do other firms grow?

A
  • A firm will experience EOS decreasing COP, sell more goods ^Revenue. Therefore ^Profit.
  • Larger firm has greater market share, more influence over prices, and ability to restrict other firms entering market.
  • Larger firms can build up assets and cash which can be used in financial difficulties.
67
Q

What is a demerger? Give example

A

When a firm splits into two or more independent businesses e.g. Pepsi announced a demerger of its Pizza Hut, KFC and Taco Bell restaurants to focus on competition with Coca Cola.

68
Q

Give 4 reasons for demergers

A
  • Avoid diseconomies of scale and dis-synergies (negative effects of takeovers e.g. higher costs/lower revenues)
  • Value of share price greater separately than together
  • Eliminate culture clash
  • Refocus on core activities
  • Reinvigorate brand
69
Q

Give 2 benefits of a demerger

A
  • Focus on core activities
  • Easier to manage
  • Cost savings
70
Q

Give impact of demerger on workers and consumers

A

Workers; Job creation, more management opportunities
Consumers: Lower prices if avoid DOS

Economics Micro - No Diagrams (5 decks)

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