Types of Markets - Oligopily Flashcards
Define Oligopoly
Where you have a few large firms that control a market.
For example, supermarkets - Tesco’s, Sainsbury’s, Asda.
How do you measure an Oligopoly?
We measure an Oligopoly in terms of the market share - the largest businesses within that market I.e. :
Market share = [(sales of firm x)/total market sales)] * 100
What is/how do we work out the concentration ratio?
We work out the concentration ratio by adding up the sales of the largest firms in the market.
Usually, any 3 firm concentration ratio around 40% would be an Oligopoly.
What are the main characteristics of Oligopolies?
1-Just a few large firms that dominate the market
2-Tend to be significant ant barriers to entry into the market
3-Tend to earn fairly high supernormal profits because they have a lot of power in the market
4- Large enough to benefit from economies of scale
5- The markets tend to be highly interdependent I.e. the success of any one firm depends to a large extent on what other firms do
6- These firms tend to compete using large levels of non-price competition e.g. Advertising, improving products.
7- Incentive to try to work together - so they can charge higher prices and therefore make higher profit. The technical term is collusion and it is illegal.
What are the 2 main ways a collusion occurs?
1- Through formal agreements i.e. they have agreed what prices to charge - there will be no evidence - sometimes referred to as a cartel
2- Through an informal agreement - where there is no actual agreement, but businesses know what to do because thats the way they have always done business. e.g. price leadership - where the largest firm will put up their prices. The market accepts it because if they don’t it could lead to a price war where the largest firm will win.
What is Game Theory?
This is an idea developed by mathematicians to explain situations of uncertainty where the outcome will depend on the different decisions that people actually make. Because of this we can apply this to Oligopoly.
What is the Nash Equilibrium?
This is a table that we can use to explain why firms under Oligopoly will try to avoid competing in terms of price. We can do this by drawing the Nash matrix.
We assume there are only 2 firms - A and B - and they have two pricing options - High or Low prices.
Box:
1- Both benefit - charging high prices
2- A will benefit (charges low), B will lose out (Charges high therefore loses customers)
3-B will benefit (charges low), A will lose out (Charges high therefore loses customers)
4-Both lose (Only long-run equilibrium) (Both charge low prices, so no change in customers but fall in profit)
Therefore, any attempt by businesses to gain a short term advantage by reducing price and moving out of box 1 will lead to, in the long-run, both businesses in box 4.
In theory, the only long-run equilibrium position for the Nash Matrix where no company has incentive to change their prices, is box 4 where they are already both charging low prices.
Why do price wars break out?
1- The economy is in a recession - people have less money which puts pressure on businesses to lower prices
2- If the market in in decline e.g. CD’s
3- If new businesses are trying to enter the market, existing businesses want to stop this
4- To increase market share
Advantages of Oligopoly
1 - Firms under oligopoly should be big enough to benefit from economies of scale - so even though the market may not be very competitive, it may still be fairly efficient
2 - These firms will tend to achieve fairly dynamic efficiency due to supernormal profit and non-price competition.
3 - Large firms allow us to compete internationally. This is important because it helps employ people and create jobs. This increases the number of people paying taxes and helps us improve exports.
4 - Because they make large profits they can afford to take a stakeholder approach to the way they run their business, such as protecting the environment therefore reducing negative externalities (and avoiding a bad reputation)
Disadvantages of Oligopoly
1 - Consumers have less choice
2 - They might work together to put up their prices
3 - Because firms aren’t very competitive, and are already making high profits, they will not be under enough pressure to achieve productive or allocative efficiency
4 - Under oligopoly, firms might deliberately make it very difficult for new businesses to get into the market.
