Oligopoly

assumptions

• few sellers

• 4 or 5 largest firms control a major share of market

• high barriers to entry

• can be homogenous or heterogenous goods

market concentration ratio

total sales of an individual firm divided by total market sales

rule of thumb

4 largest firms have over 50% of market

interdependence

action of one firm affects other firms in the market

collusive behaviour

occurs when firms cooperate to fix prices & restrict output

non collusive behaviour

occurs when firms actively compete to maintain/increase market share

strategic behaviour

each firm tries to predict the actions of rival firms, and to base its own actions on how it expects its rivals to behave

also called strategic interdependence

what does non collusive oligopoly lead to?

price wards. price wars makes all the firms of an industry collectively worse off due to lower prices and lower profits

what incentives are there for oligopoly firms

• incentive to collude

• incentive to cheat in a collusive agreement

incentive to collude

• make an agreement to fix prices and share the market between themselves to limit competition

incentive to cheat in a collusive agreement

firms face incentive to compete with each other for the purpose of capturing part of their rival firms’ market share

non price competition

• brand loyalty

• packaging

• sales promotion

• special features

• ads

• personal selling

• publicity

• sponsorship

why is non price competition important for oligopoly?

• avoid price wars

• decrease price elasticity by developing new products

• product differentiation can increase firm’s profit

• takes time for rivals to develop new competitive products

• firms have financial resources that is devoted to R&D and advertising

what is a collusive agreement called?

a cartel

what do they do in a cartel?

firms agree on price, market share, advertising, etc, to reduce uncertainty in the industry and the losses that would come about if they competed with each other

problem with cartel?

• usually illegal on the ground that they inhibit competition and are against public interest

• firms may break the law and risk being caught and fined

why are cartels difficult to maintain?

• cartel members face the incentive to cheat by lowering their price secretly

• cheating by one or more firms may lead to price war

• differing costs of production: some firms could have higher fixed costs

• lack of dominant firms

• the more firms in the cartel, the easier to break down

informal collusion

• refers to the co-operation that is done implicit between co-operating firms without formal agreement

• objective is to co ordinate price cutting, limit competition

another form of informal collusion?

set the same price as the dominating firm

price rigidity

Firms avoid changing prices because raising them causes a severe loss of market share, while lowering them triggers destructive price wars. price stays stable even if market or demand changes.

pros of oligopoly

• economies of scale can be achieve

• research and development of products

• technical innovations

• possible consumer variety

cons of oligopoly

• welfare loss, allocative inefficiency, market failure

• higher price and lower output

• loss of consumer surplus

• possibly less innovative

• may be higher production costs due to lack of price competition