Oligopoly

• Concentration ratio


  A measure of the collective market share of the largest firms in an industry
• How to calculate a concentration ratio


  1. Identify the n largest firms

  2. Add up their individual market shares

  3. Write as n:collective market share
• Concentration ratios measure the collective market share of the largest firms, not individual firm dominance
• Oligopoly


  • Few firms dominate the market
  • High concentration ratio (no more than 7 firms with 70% market share)
  • Firms have differentiated/unique goods
  • High barriers to entry and exit
  • Interdependence - firms make decisions based on actions/reactions of rivals
  • Price rigidity
  • Non-price competition (branding, advertising, quality)
• Global oligopoly examples


  • Global soft drink industry (Coca-Cola, Pepsi)
  • Global car industry
  • OPEC (Petroleum Exporting Countries)
  • UK supermarket industry
  • UK energy industry
  • UK supermarket fuel providers
  • UK bus market
  • UK airline market
• Kink Demand Curve model

  1. Differing price elasticities of demand around current market price

  2. Firms don't want to raise price (lose market share)

  3. Firms don't want to lower price (price war, revenue decrease)

  4. Marginal revenue curve has vertical gap

  5. As long as costs change within vertical gap, profit-maximising firm will charge same price
• Interdependence in oligopoly


  • Frustrating for firms
  • Strong temptation to collude and fix prices to make high profits
• Even though price changes don't make sense, there may still be price wars and price competition in oligopoly
• Non-price competition (branding, advertising, quality) is common in oligopoly due to price rigidity
• Game theory can also be used to map oligopoly behaviour
• Competitive oligopoly


  Oligopolists engage in price wars or compete on non-price factors like branding, advertising, quality, or standards
• Collusive oligopoly


  Oligopolists engage in overt collusion (fix prices or quantities) or tacit collusion (informal agreements not to engage in price wars, or price leadership)
• Factors promoting competitive oligopoly


  • Many firms in the market
  • New market entry is possible
  • One firm has significant cost advantages
  • Homogeneous goods
  • Saturated market with price wars
• Factors promoting collusive oligopoly

  • Few firms in the market
  • Firms have similar costs
  • High barriers to entry
  • Ineffective competition policy
  • Consumer loyalty
  • Consumer inertia
• Evaluating competitive oligopoly


  
  

  • Assess pros and cons of competitive market outcomes (static efficiency, dynamic efficiency, economies of scale)
  • If the oligopoly is competitive, evaluate it as a competitive market
• Evaluating collusive oligopoly


  
  

  • Assess pros and cons of monopoly outcomes (static inefficiency, dynamic efficiency, economies of scale)
  • If the oligopoly is collusive, evaluate it as a monopoly
• Oligopoly

  A market structure with a small number of firms that are interdependent
• Game theory


  A framework for understanding the strategic interactions between interdependent firms
• Game theory can provide more nuanced and detailed conclusions about oligopolistic firm behaviour than the kinked demand curve model
• Prisoner's dilemma


  A game theory model where two players have an incentive to defect from cooperation, even though cooperation would provide a better outcome for both
• Applying the prisoner's dilemma to oligopoly

  1. Firms A and B face a decision on whether to charge a high price (£1) or a low price (90p)

  2. The payoff matrix shows the profits for each firm under the different pricing strategies

  3. The Nash equilibrium is where both firms charge the low price of 90p

  4. This leads to price rigidity at 90p and competition on non-price factors
• The Nash equilibrium in the prisoner's dilemma

  Is not the best outcome for the firms combined, as they could earn higher profits by colluding to charge the high price of £1
• Even with a collusive agreement to charge £1

  There is an incentive for each firm to undercut the other and charge 90p to earn higher profits, threatening the stability of the collusion
• Competition authorities may also deter collusion by the threat of being caught and penalized
• Understanding oligopoly behaviour requires considering both the kinked demand curve model and game theory insights