3.4.4 Oligopoly

imperfectly competitive

market structures where firms do have some market power and can influence prices

what do most imperfectly competitive industries operate in

oligopoly market structure E.g., Banks, insurance companies, department stores, supermarkets, petrol retailers, sport stores etc.

oligopoly

market structure in which a few large firms dominate the industry with each firm having significant market power

characteristics of an oligopoly market

• high barriers to entry and exit

• high concentration ratio

• interdependent - actions of one firm will directly affect another

• highly differentiated products

concentration ratio

reveals what percentage of the total market share a specific number of firms have

10-firm concentration ratio

reveals the total market share (concentration) of the top 10 firms in the industry

5-firm concentration

reveals the total market share (concentration) of the top 5 firms in the industry

when would it be considered an oligopoly

five-firm concentration ratio of around 60%

when would it be pure monopoly

one-firm concentration ratio of 100%

what do CMA define monopoly

firm with more than 25% market share,It prevents mergers or acquisitions from taking place which would give one firm more than 25% market share

how to calculate concentration ratio

• identify top n firms by value of sales and value of sales together

• calculate percentage of total sales that top n firms have

types of price competition

• price wars

• predatoy pricing

• limit pricing

price wars

competitors repeatedly lower prices to undercut each other to gain or increase market share

example of using price wars

supermarkets

predatory pricing

lowering prices when a new competitor joins the industry to drive them out it is illegal as anticompetitivel

limit prices

firms set a limit on how high the price will go in the industry a lower price reduces profit and disincentives other firms from joining the industry the greater the barriers to entry the higher the limit price is likely to be as firms are already disincentivised

non price competition

competition that is not based on price

examples of non price competition

• loyalty cards and rewards

• branding

• packaging

• celebrity/influencer endorsemenet

• Corporate sponsorship e.g. Nike sponsoring Rafael Nadal

• After sales service

• Delivery policies

• Product warranties

kinked demand theory

• if a firm rises it’s prices other firms will not follow wince they know their comparatively lower price means they are more competitive

• however if a firm lowers its its price, other firms will follow since they want to remain competitive. Therefore, we assume price starts at P1: above P1 the curve is elastic (since competitors are offering lower prices) and below P1 the curve is inelastic (since other firms lower their prices too so there is a little difference in sales for the original firm). The result is a kink in demand. This kink in demand means that there is a gap in the MR curve and so a rise or fall in costs or demand is likely to have no impact on price or output. Because of this, prices in oligopolistic markets tend to be stable.

problem with kinked demand curve theory

• does not explain how optimal price set

• deals only with price competition

• assumes particular reaction by rivals

• firms sell multiple products

what would happen if bp raises petrol prices

• rivals do nothing

• bp will lose market share as customer chose alternaties

  • lose revenue and profit

what would happen if bp reduces petrol prices

• very quick win

• rivals follow with own price reduction

• price war leads to loss in revenue and profits for whole market

advantage of oligopoly

• competitive oligopoly can elad to price wars which then increases consumer surplus

• lower prices

• higher levels of research and development

• can exploit internal eos which then leads to lower average costs and lower price sin long run

• high supernormal profits can be taxed so revenue to help public services

disadvantagesof oligopolies

• cartel behavious lesad to high er prices loss of allocative efficient and hurting low income households

• high conc ratio limites consumer choice and barriers to enrty may deter innovative smaller firms from pprofitable entry

• high levele of spending on branding and advertising can increase production costs passed onto consumers as higher prices

• many transnational oligopolies avoid paying tax through shadow or transfer pricing leaving with lower gov revenue

collusive behaviour

occurs when firms cooperate to fix prices and restrict output

non collusive behaviour competitive

when firms actively compete to maintain/increase market share

formal collusion ovet

agreement between firms -cartel usually illegal

informal collusion tacit

happens without an agreement not in firms best interest to compete

reasons for collusion

• few firms/competitors

• similar costs

• similar revenue

• high barriers to entry

• ineffective regulation

• brand loyalty

consequences of overt collusion

• Higher prices for consumers

• Less output in the market

• Poor quality products and/or customer service

  • Less investment in innovation

what ways does overt collusion happen

• Price fixing

• Setting output quotas which limit supply and naturally results in price increases

• Agreements to block new firms from entering the industry

• Agreements to pay suppliers the same price thereby driving down prices in the supply chain (monopsony power)

most common form of tacit collusions

price leadership or price matching

• This occurs when firms monitor the price of the largest firm in the industry and then adjust their prices to match

• It is difficult for regulators to prove that collusion has occurred

• It provides similar benefits to firms as overt collusion, but perhaps not to the same degree

• It has similar consequences for consumers as overt collusion, but perhaps not to the same degree

effect of collusion on producers

• increased sales revenue and profit

• increase in producer surplus

• increase of non price competition

• increase in ibestment in innovation and research and develoment

effect of collusion on consumers

• higher price charged

• reduction of consumer surplus

• restricted output

• increase in non price competiiont benefits customers

apple collusion example

colluded with publishers to increase ebook prices but ahd to py out 450m in court to reimburse consuemrs who were overcharged

efficiency in oligopolies

• static inefficient as not productively or allocatively efficient

• dynamically efficient as make supernormal profits so have funds to invest

game theory

study of how people make decisions when they are interacting with others and how their choices depend on what others do

why is game theory used in economics 

to understand strategic behaviour especially in oligopolies where a few large firms dominate the market

prisoners dilemma

famous idea in game theory that shows why 2 people may not cooperate even if working together is best for both

payoff matrix

outcome of players given different possible strategies

dominant strategy 

move that gives a better outcome no matter what the other player does