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Undeleted > Unit 3: Oligopoly > Flashcards

Unit 3: Oligopoly Flashcards

1
Q

What is an Oligopoly?

A

A market dominated by a few producers, each of which has control over the market

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2
Q

What are the Characteristics of an Oligopoly?

A
  1. Supply is concentrated in the hands of relatively few firms
  2. Firms are interdependent, the actions of one firm affects others in the industry
  3. Goods may be homogenous or differentiated
  4. Firms often engage in non-price competition
  5. There are periodic aggressive price wars
  6. Firms may collude
  7. Prices are stable
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3
Q

What are some Examples of Oligopolies?

A 
Energy suppliers
Commercial banks
Pharmaceutical retailers
Mobile phones
Soft drink manufacturers
Supermarkets
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4
Q

What is meant by the Concentration Ratio?

A

The concentration ratio measures market share of the top ‘n’ firms in an industry
Shares can be by sales, employment, or any other indicators

How to calculate: Just add it up

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5
Q

What are the coefficients of the Concentration Ratio?

A

High number - the industry is highly concentrated, and dominated by a small number of firms

Low number - the industry is more highly competitive

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6
Q

What type of Demand Curve does an Oligopoly have?

A

Kinked Demand Curve

Used to illustrate the behaviour of firms in an oligopoly
It consists of 2 demand curves- elastic demand & inelastic demand

The square/rectangle underneath the equilibrium shows Total Revenue

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7
Q

What would happen if a firm in an Oligopoly Increased the Price of their product?

A

Elastic Curve:

A firm increases the price
Other firms’ rices haven’t changed
Those demanding that firm’s product will new switch to the substitutes
They lose market share (elastic demand- a price inc. will reduce a lot of demand)

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8
Q

What would happen if a firm in an Oligopoly Decreased the Price of their product?

A

Inelastic Curve:

A firm decreases the price
To prevent competition and loss in market share, the other firms decrease their prices (price war)
The firm’s revenues decrease (inelastic demand)

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9
Q

Why do prices tend to remain Stable in an Oligopoly?

A

Total revenue is maximise ‘at the kink’.

If price increases and demand is elastic, total revenue falls.
If price decreases and demand is inelastic, total revenue decreases.

As a result of the above, prices tend to remain stable as firms are reluctant to change prices up or down

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10
Q

What is meant by Collusion?

A

Collusion represents an attempt by firms to recognise their interdependence, and act together rather than compete.

It is a move towards joint profit maximisation

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11
Q

What is a Cartel?

A

A cartel is a formal agreement among competing firms

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12
Q

What are the Two Types of Collusion?

A

Overt Collusion

Tacit Collusion

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13
Q

What is Overt Collusion?

A

A price-fixing agreement with a producer cartel responsible for allocating output/supply within the market

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14
Q

What is Tacit Collusion?

A

A dominant firm is the price leader, and others follow

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15
Q

Are Cartels legal or illegal?

A

Illegal

Firms that operate a cartel can now be fined up to 10% of their UK turnover for up to 3 years

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16
Q

When is Collusion Easier?

A

Collusion is easier when..

There is only a small number firms in the industry (??)
The industry has substantial high barriers (??)
Firms output can be easily manipulated (??)
Total market demand not too variable
Low YED, Inelastic PED

17
Q

What is Price Leadership?

A

Price leadership occurs when one firm changes their prices, and other firms follow.

Other firms are often forced into changing their prices too; otherwise they risk losing their market share.

The price leader is often the 1 judge to have the best knowledge of prevailing market conditions

This explains why there is price stability in an oligopoly

18
Q

What is Game Theory?

A

Game theory refers to the interdependence between firms in an oligopoly.

It is used to predict the outcome of a decision made by one firm, when it has incomplete information about the other firm.

19
Q

What is the Prisoner’s Dilemma?

A

A model based around two prisoners, who have the choice to either confess or deny a crime.

The consequences of the choice depends on what the other prisoner chooses.

The two prisoners are not allowed to communicate, but they can consider what the other person is likely to choose.

This relates to the characteristic of uncertainty in an oligopoly.

20
Q

What is meant by the Dominant Strategy?

A

The dominant strategy is the option which is best, regardless of what the other person chooses.

This is for both prisoners to confess since this gives the minimum number of years that they have to spend in prison.

It is the most likely outcome.

21
Q

What is meant by the Nash Equilibrium?

A

(The dominant strategy is still higher than if both prisoners deny the crime.
However, if collusion is allowed in this dilemma, then both prisoners would deny. This is the Nash equilibrium.)

A concept in game theory which describes the optimal strategy for all players, whilst taking into account what opponents have chosen.

They cannot improve their position given the choice of the other.

However: Even if both prisoners agree to deny, it would have an incentive to cheat and therefore confess, since this would reduce the potential sentence from 2 years to 1 year – this makes the Nash equilibrium unstable

22
Q

What is meant by Price Strategies?

A

When firms use the price of their product to influence market share.

It’s not very much used, as prices tend to be stable

23
Q

What are the Types of Pricing Strategies?

A

Price Wars
Predatory Pricing
Limit Pricing

Psychological Pricing: Giving prices that end in 9; It’s psychologically seen as a separate, cheaper price. (eg 99p vs £1)

Price Skimming: Giving a high price at the launch of a product. Once the top end of the market (those willing to pay the most) has been ‘skimmed’, they lower their prices. iPhones tend to do this.

Price Penetration: Giving a low price initially, in order to gain market share/ customer base/ hope. This tends to occur when the business is targeting a mass market

Loss Leader: When a business sets the price below the cost of the product. This can attract customers to a store, where they will also buy additional products. Some firms sell the core product as a loss leader and make additional sales by selling accessories of the product

24
Q

What is meant by Non-Price Strategies?

A

When firms don’t use the price of their product to influence market share. These aim to increase the loyalty to a brand, which makes demand for a good more price inelastic.

These strategies are mainly used within firms in an oligopoly

25
Q

What are the Types of Non-Price Strategies?

A

Advertising and Marketing: Used to make their brand more known, and influence consumer preferences. However, it’s unknown how significant A+M is to each firm- if it’s ineffective, this leads to more sunk costs, which are unrecoverable

Customer service: e.g. Having more available delivery times, longer opening time, after sales service (guarantees + warranties, etc)

Differentiation of the product: e.g. Brand name, logo, catchphrases, unique selling point. If firms can increase brand loyalty, demand comes more price inelastic. This attracts + keeps customers, increasing market share.

Quality of products

26
Q

What are the Benefits of Collusion?

A
  1. Industry standards could improve
    (especially true in the pharmaceutical industry/ car safety technology; as firms can collaborate and improve on it.)
  2. Excess profits could be used for investment, which might improve efficiency in the long run. It may also be used on dividends.
  3. It saves on duplicate research + development
  4. By inc. their size, firms can exploit economies of scale, leading to lower prices.
27
Q

What are the Costs of Collusion?

A
  1. There’s a loss of consumer welfare (as prices are raised + output is reduced)
  2. Less competition means efficiency falls
  3. Reinforces the monopoly power of existing firms, making it hard for new firms to enter
  4. Lower quantities supplied leads to a loss of allocative efficiency.
28
Q

What are Price Wars?

A

Price Wars occur when price cutting leads to retaliation and other firms cut prices, meaning the original firm again wants to cut prices.

+: The lower prices increase demand; Consumers benefit from low prices

-: All firms lose revenue.

29
Q

What is Predatory Pricing?

A

Cutting prices below the average cost of production. (It can even go below AVC)
This is a short term measure only, and once other firms are forced out of the market they rise their prices back up

This is almost always illegal.

+: Forces firms out of the market

  • :Illegal
  • :Is it really worth it in the long term?
30
Q

What is Limit Pricing?

A

It ensures the price of good is below that which a new firm entering the market would not be able to sustain. Potential firms are therefore unable to compete with existing firms.

  • : The low profits received by that firm dissatisfying shareholder, since they receive lower dividends
31
Q

What are the Reasons for Collusive and Non-Collusive Behaviour?

A

Collusive behaviour occurs if firms agree to work together on something. For example, they might choose to set a price or fix the quantity of output they produce, which minimises the competitive pressure they face.

Collusion leads to a lower consumer surplus, higher prices and greater profits for the firms colluding.
Firms in an oligopoly have a strong incentive to collude. By making agreements, they can maximise their own benefits and restrict their output, to cause the market price to increase. This deters new entrants and is anti-competitive.

Collusion is more likely to happen where there are only a few firms, they face similar costs, there are high entry barriers, it is not easy to be caught and there is an ineffective competition policy.

Moreover, there should be consumer inertia. All of these factors make the market stable.

Non-collusive behaviour occurs when the firms are competing. This establishes a competitive oligopoly. This is more likely to occur where there are several firms, one firm has a significant cost advantage, products are homogeneous and the market is saturated. Firms grow by taking market share from rivals.

32
Q

What does the Oligopoly Diagram look like?

A

http://www.economicsonline.co.uk/Business%20economics%20graphs/Oligopoly-kinked-demand.png

33
Q

What are Cartels Unstable?

A

Firms can cheat on any agreement, and there’s always the threat of being caught by competition authorities.

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