Oligopoly

• Characteristics of oligopolies:

  • Small number of large firms
  • Goods and services are differentiated
  • High barriers to entry and exit
  • Firms in an oligopoly are interdependent
  • A lot of non-price competition
  • Objective of oligopolists may vary
• Collusion occurs when two or more firms agree to limit competition, there are two types of collusion: overt and tacit
• Overt collusion is a formal agreement between firms, this is when firms communicate with each other to avoid competition by reaching a price agreement. This means they can benefit from a high level of prices which is bad for consumers
• Tacit collusion is an unspoken agreement between firms, this means firms try to avoid engaging in price competition. They raise prices to a similar level and this is called price leadership, firms understand that lowering prices will result in a price war where profits are reduced
• Overt collusion is illegal while tacit is legal
• There are three main forms of price competition in oligopolies:

  • Price wars which is when firms lower their prices to undercut their competitors
  • Predatory pricing is when firms reduce prices to below AVC in the short run to run competitors out the market
  • Limit pricing occurs when large firms use their economies of scale to keep prices permanently low enough in order to deter new firms from entering the market
• Possible outcomes of Oligopolistic competition:

  • Firms can compete on non-price factors
  • Firms can compete on price
  • Firms could collude and form a cartel
  • Firms can engage in tacit collusion / price leadership
• Increase likelihood of oligopoly collusion:

  • Small number of firms
  • Similar costs to each other
  • Barriers to entry are high
  • Consumer brand loyalty is strong
  • Strong consumer inertia
  • Low price volatility
• The kinked demand curve for non-collusive oligopolies is a way of explaining the behaviour and why prices tend to be rigid in oligopolies
• Oligopoly possible outcomes:

  • Firms could compete on non-price factors
  • Firms could compete on price
  • Firms can break interdependence by forming a cartel or colluding
  • Firms can break interdependence by using tacit collusion
• Increase likelihood of becoming collusive:

  • Small number of firms
  • Similar costs for firms
  • Barriers to entry are high
  • Consumer brand loyalty is high
  • Strong consumer inertia
  • Low price volatility