oligopoly

Created by

Tanisha Memmi :]

Cards (44)

key features of an oligopoly
few dominant firms
barriers to entry
interdependence - decisions + actions of one firm significantly impacts the other firms due to limited number of competitors
strategic behaviour
non-price competition
types of oligopoly - collusive oligopoly
firms in an oligopolistic market coordinate their actions + make joint decisions to maximise collective profits, can occur through formal agreements like cartels or informal understandings known as tactic collusion
cartels - formal agreement among competing firms to control prices, production levels and market shares, often illegal as they reduce competition + harm consumer welfare, some cartels may receive legal recognition or operate in certain industries under gov. regulations
types of oligopoly - collusive oligopoly
tactic collusion - firms implicitly understand + follow certain pricing/production behaviours to avoid intense competition, may happen through repeated interactions + mutual observation of behaviour in the market
price fixing - agree to set a specific price/price range for their products, eliminates price competition + allows firms to maintain higher prices + profits
output restrictions - cartels may impose this on member firms to limit supply + maintain higher prices, can prevent price erosion + ensure profitability for all participants
advantages and disadvantages of collusive oligopoly
can provide stability, reduce uncertainty and enhance profits for participating firms
maintaining collusion can be challenging due to temptation for individual firms to cheat and gain a competitive advantage - prisoner's dilemma, concept of game theory, illustrates the conflict of interest that can arise within a collusive oligopoly
types of oligopoly - non-collusive oligopoly
a situation where firms in an oligopolistic market compete against each other without formal agreements to coordinate their actions
firms rely on strategic decision-making and interdependent to gain a competitive edge
types of oligopoly - non-collusive oligopoly
strategic behaviour - firms consider the likely reactions of their competitors when making pricing, production, or marketing decisions, aim to anticipate and respond effectively to the actions of rival firms
differentiation + branding - often focus on product differentiation, branding + marketing efforts to attract customers, can gain competitive advantage
non-price competition - customer service, R&D for innovative products, improving quality of goods + services to differentiate
types of oligopoly - non-collusive oligopoly
game theory - to analyse and understand their strategic interactions, helps firm predict and respond to the actions of their rivals, considering potential payoffs and outcomes of their decisions
barriers to entry - often have high barriers to entry making it difficult for new firms to enter and compete in the market, barriers can include substantial capital requirements, economies of scale, legal regulations, or strong brand loyalty established by existing firms
game theory
helps firms understand how their choices and actions affect their competitors ad vice versa
Prisoner's Dilemma is a commonly used game theory model to explain why firms might struggle to cooperate and engage in collusive behaviour
pricing strategies
price leadership - one dominant firm sets the price, others typically follow suit to maintain market stability
price rigidity - oligopolies tend to keep prices stable to avoid price wars and maintain profits
price discrimination - some oligopolistic firms may engage in price discrimination by charging different prices to different customer segments based on their willingness to pay
advantages of oligopoly
economies of scale leading to cost efficiencies
innovation - firms have resources to invest in R&D, leading to product innovation and technological advancements
quality and variety - often offer high-quality products with a wide range of choices to attract customers
disadvantages of oligopoly
reduced competition - can result in higher prices, reduced consumer choice, and lower allocative efficiency
collusion and cartels - can harm consumer welfare by reducing output and raising prices
barriers to entry - make it challenging for new firms to enter the market, reducing innovation and competition
examples of oligopolistic industries
car industry - few large firms dominate the global automobile market, such as Toyota, Volkswagen and General Motors
soft drink industry - companies like Coca-Cola and PepsiCo control a significant share of the soft drink market
mobile phone industry - Apple and Samsung are major players in the mobile phone industry
payoff matrix
used to represent the possible outcomes and payoffs for each firm based on different combinations of strategies chosen by all players
help analyse strategic interactions between firms
dominant strategy
occurs when a firm's choice yields the highest payoff regardless of the actions taken by other firms
if it exists, a rational firm will always choose that strategy, anticipating that others will act int their own self-interest as well
nash equilibrium
central concept of game theory
representing a stable outcome in which no player has an incentive to unilaterally change their strategy
reached when each firm's strategy is the best response to the strategies chosen by its competitors
state of mutual interdependence and strategic balance
prisoner's dilemma
demonstrates the difficulty of achieving cooperation in competitive situations
shows that rational self-interest often leads to suboptimal outcomes
basics of an oligopoly
best defined by the actual conduct of firms within a market
an imperfectly competitive industry where there is a high level of market concentration
concentration ratio measures the extent to which a market or industry is dominated by a few leading firms
rule of thumb is that an oligopoly exists when the top five firms in the market account for more than 60% of total market sales
may sell homogenous products - engage in collusion or they sell heterogeneous/differentiated products and there is likely to be fierce non-price competition
key characteristics of an oligopoly
best defined by the actual behaviour of firms
a market dominated by a few large firms
high market concentration ratio
products can be differentiated or homogenous
significant barriers to entry and exit
interdependent strategic decisions by firms
cost and revenue diagram for oligopoly
oligopoly examples
airlines
broadband providers
vehicle manufacturers
high street banks
pharmaceutical companies
cinema chains
fizzy drink makers
household goods
duel retailers
kinked demand curve
business in oligopoly has downward sloping demand curve, PED depends on reaction of rivals to changes in one firm's price + output
rivals don't follow price increase by 1 firm, acting firm lose market share, demand will be elastic + rise in price will lead to fall in revenue
rivals match a price fall by one firm to avoid a loss of market share, demand will be more inelastic + a fall in price will lead to a fall in revenue
little incentive for any firm in the industry to change their price as it's likely to lead to a fall in total revenue, prices tend to remain stable
kinked demand curve
price above P1 - firms likely to hold their prices - elastic - less sales + total revenue
price below P1 - firms likely lower price - inelastic demand - little benefit in terms of extra sales + total revenue
if demand is elastic from increase in price + inelastic from decrease in price - create a kink in oligopolistic demand curve (AR)
price at the "kink" in theory has no incentive to move away from it
kinked demand curve - equilibrium
MR curve is always twice as steep as AR
2 MR curves if AR is kinked
find a vertical intersection - at Q1, two curves don't intersect
kinked demand curve - equilibrium
MC1 cuts through any point in the gap in the MR curve
kinked demand curve - price rigidity
MC has changed but it intersects MR at the same level of output - no change in output or price
prices will be "sticky" even when there is a change in the marginal costs of supply
kinked demand curve
in oligopoly, firms have price-setting power but may be reluctant to use it
rivals unlikely to match a price rise and rivals likely to match a price fall
if a firm is settled on one price, there may be little point in changing it
even if costs change we often see price rigidity/stability in an oligopoly
this increases the importance attached to non-price competition
real world examples of price wars
low cost airlines
supermarkets
mobile phone tariffs
impact of a price war on suppliers
can make suppliers close to bankruptcy (exploited farmers)
price wars
may lead to short run increases in sales and revenues, but may not be in the long-term commercial interests of a business
winners in a price war: customers, managers (higher sales), shareholders(short term)
losers in a price war: suppliers, shareholders (long term, lower profits), small run businesses (family run businesses)
oligopoly and collusion
collusion is a form of anti-competitive behaviour
a secret agreement between two or more parties to limit open competition by deceiving, misleading, or defrauding others of their legal rights, or to obtain an objective forbidden by law typically by defrauding or gaining an unfair market advantage
collusion can be; horizontal, vertical, explicit, tacit (not illegal e.g. price wars)
occasionally collusion between business is legal
collusion
most collusion is against the law and would be investigated by the Competition and Markets Authority (CMA)
firms could face high fines for collusion
legal collusion/business cooperation
not all instances of collusive behaviour are deemed to be illegal by the European Union Competition Authorities
practices are not prohibited if the respective agreements "contribute to improving the production or distribution of goods or to promoting technical progress in a market" - e.g. information sharing designed to give better information to consumers, development of improved industry standards of production and safety which benefit the consumer - joint industry in Europe for mobile phone chargers
key aims of business collusion
businesses in a cartel recognise their mutual interdependence and act together - main aim is to maximise joint profits
collusion lowers the cost of competition e.g. wasteful marketing wars which can run into millions of pounds
collusion reduces uncertainty in a market - higher profits, larger producer surplus/shareholder value leading to higher share price
when might price fixing (collusion) be easier
industry regulators are weak/ineffective
penalties for collusion are low relative to the potential gains in revenues/operating profits
participating firms have a higher % of total sales - allow them to control market supply
firms can communicate well and trust each other and have similar strategic objectives
industry products are standardised and output is easily measurable
strong brands - consumers won't switch demand when collusion raises price
why do many cartels break down
falling market demand in a recession
over production by some members
exposure by competition authorities
entry of non-cartel firms in to an industry
penalties for cartels in the UK
businesses found to be in breach of competition law an face fines of up to 10% of their worldwide turnover
those convicted of a cartel offence can face up to 5 years imprisonment, unlimited fines, director disqualification for a period of up to 15 years and potential confiscation of their assets
advantages for 'whistleblowers'
when a company is the first to bring the cartel to the CMA's attention, they can get immunity from penalty fines
employees of whistleblowing firms are guaranteed protection from criminal proceedings
potential benefits from collusion
general industry standards can bring social benefits - pharmaceutical research, car safety technology, faster acceleration in developing new technologies
fairer prices for producer cooperatives in lower and middle income developing countries - competing with powerful monopolistic corporations, may help in reducing rates of extreme income poverty
profits have value - capital investment projects, R&D - dynamic efficiency, higher wages for employees, increase consumption
costs of collusive behaviour
damages consumer welfare - higher prices/lower consumer surplus, loss of allocative efficiency, hits lower income families
absence of competition hits efficiency - x-inefficiencies (increases unit costs), less incentive to innovate/loss of dynamic efficiency, output quotas penalise firms who want to expand
reinforces the cartel's monopoly power - harder for new businesses to enter the market - lower market contestability
evaluating collusive oligopolies
different types of collusion
look at efficiencies
costs and benefits
extent of fines
price leadership
CMA view
oligopoly theory often makes heavy use of game theory to model the actual behaviour of businesses in concentrated markets
game theory is the study of how people and businesses make decisions in strategic situations i.e. when they must consider the effect of other people's responses to their own actions
game consists of:
players
strategies
payoffs
might also involve some form of pre-commitment