5.7

• Characteristics of oligoploy

  • few firms with high concentration ratio And significant price-setting power
  • supernormal profits in the short-run and long-run
  • Barriers to entry are relatively high
  • Product differentiation
  • Interdependence between firms i.e they can often implement collusive strategies
  • Oligopoly can be defined through either its conduct (collusive or competitive), or its structure
• concentration ratio defintion

  measures the market share (percentage of the total market) of the biggest firms in the market. for examples, a five-firm concentration ratio measures the aggregate market share of the largest five firms
• firms in an oligopoly are interdependent
• what is an oligopoly?

  a market structure in which a few large firms dominate the industry with each firm having signifiant market power
• what is a cartel?

  a collusive agreement made by firms, usually to fix prices, in order to improve their profits and dominate the market, can deter the entry of new firms
• when does a competitive oligopoly exist?

  when the rival firms are interdependent - must take account of each other’s reactions when forming a market strategy, but independent in the sense that they decide their market strategies without cooperation or collusion
• what does the prisoners’ dilemma show us?

  firms can receive a greater payoff by colluding
• what is formal/overt collusion?

  a spoken agreement between firms involving price collusion and other markets rigging strategies secrectly performed between firms without the general public being aware of this
• what is tacit collusion?

  unspoken agreement between firms. often works through price leadership. It is in both firms best interest not to change prices
• likelihood of types of oligopoly

  • non-collusive oligopolies are more likely when we see: low entry barriers, a high number of firms and different marginal costs
  • collusive oligopolies are more likely when we see: high entry barriers, low number of firms, and similar marginal costs
• What is market conduct?

  the behaviour of firms within a market as regards to pricing and marketing policies
• what are joint ventures?

  a contractual agreement between two or more firms to combine their resources and expertise to achieve a particular goal
• what is a strategic alliance?

  an arrangement between two companies to join together on a mutually beneficial project while each retains its independence
• • firms in an oligopoly may engage in a price war
  • by fiercely cutting prices, firms are trying to gain market share
  • the idea is that by aggressively cutting prices, you will drive other firms out of the market because they can no longer compete
  • new firms will be discouraged to enter because of the low profits being made
  • once firms have been driven out of the market, non-price competition can be used to maintain market share
• Advantages of oligopoly

  • informal collusion is less likely than it may appear, as one firm tends to defect, which brings down the entire cartel
  • This could lead to price wars, which are good for consumers due to the lower prices
  • Collusive oligopolies can achieve dynamic efficiency through non-price completion and product development
  • Competitive oligopolies also have to potential to be very efficient
• What is price fixing ?

  Occurs when competitors agree a fixed price for all of their competing products and its usually higher than market equilibrium price
• how can governments prevent collusion?

  • increasing punishments
  • Whistleblowing
  • Keeping markets competitive
• outcomes in collusive oligopoly

  • similar results to a monopoly
  • consumers likely to have lower consumer surplus and producers will have a higher producer surplus
  • firms will restrict output and raise prices close to profit maximising level
  • creates deadweight welfare loss to society and statistically inefficient
  • firms will still compete in non-price completion, particularly through marketing
• non-collusive oligopoly outcomes

  • deadweight welfare loss because output will not be at the statistically efficient level of product that would be created under perfection competition
  • output likely to be higher and prices likely to be lower than in a collusive oligopoly
• What is the kinked demand curve theory?

  Explains price stability in oligopolies. Firms believe:

  • if they raise prices, rivals wont follow - lose market share
  • If they cut prices, rivals will follow - no gain in sales

  so the demand curve Is:

  • elastic above current price (bad if price increase)
  • Inelastic below current price (bad if price decreases)
• why is there a ‘kink’ in the demand curve?

  firms face two different elasticities:

  • high elasticity if price goes up
  • low elasticity if price goes down
• what does the kinked demand curve suggest about price changes in oligopoly?

  firms are reluctant to change prices - even if costs change - due to fear of starting a price war or losing customers
• what is price leadership?

  the setting of prices in a market, usually by a dominant firm, which is then followed by other firms in the same market
• why do firms follow price leadership?

  to avoid price wars, reduce uncertainty and behave collusively without formal agreements
• what is price agreement/collusion?

  an agreement between a firm, or similar firms, suppliers or customers of a good or service to set prices - reducing competition and often acting like a monopoly
• what’s the difference between overt and tacit collusion?

  • overt - open agreements (e.g cartels)
  • tacit - silent cooperation (e.g following price leader)
• is collusion legal ?

  • overt collusion is illegal in most counties (UK & EU)
  • tacit collusion is harder to regulate and may occur subtly
• what is a price war?

  when firms repeatedly undercut each other to gain market share - causing prices and fall and profits to drop
• why are price wars damaging in oligopoly ?

  • leads to lower profits
  • unsustainable long term
  • can force weaker firms out of the market
• how do oligopolies avoid price wars?

  • price leadership
  • non-price competition (branding, customer service, loyalty schemes)
  • implicit coordination