oligopoly

• 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

  1. businesses in a cartel recognise their mutual interdependence and act together - main aim is to maximise joint profits
  2. collusion lowers the cost of competition e.g. wasteful marketing wars which can run into millions of pounds
  3. 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:

  1. players
  2. strategies
  3. payoffs
  4. might also involve some form of pre-commitment