3.4.4 Oligopoly

Characteristics of oligopoly

• few, large interdependent firms dominate industry → high concentration ratio

• similar products

• imperfect knowledge

• high barriers to entry

• price-maker

• profit-max

• focus on non-price competition

• firms don’t make decisions on their own independently, they make decisions based on actions of rival firms

Concentration ratio

• measures competitiveness of markets by assessing market share of dominant firms

f- rule: if 5/fewer firms control 50% or more of market → oligopoly

Calculation:

3 firm concentration ratio = add 3 largest percentage tgt

(Sum of …largest (exclude others) / sum of all (include others) ) x 100

Examples of oligopoly

• low cost airline

• commercial banks

• cinemas

• Supermarkets

• Telecommunications

Difference between price competition & non-price competition

• Both are used to attract customers to out-compete rivals

• Price competition: lower prices to attract customers

• Non-price competition: other strategies to attract customers

Types of price competition

• predatory pricing

  • 1) set price below costs - hard to match price / loss in SR - drive existing competitors (rivals) out of market

  • 2) keeps competition out

  • 3) When competition is removed, raise price

    • illegal

• Limit pricing

  • set price below profit max - at a level potential new firms cannot achieve - barriers of entry - restrict entrance of new rivals

Types of non-price competition

Since price competition may not be as effective in oligopoly due to game theory showing firms will eventually charge at Nash equlibrium causing price rigidity so compete on non-price competition instead

• Advertising

  • loyalty cards

  • tech: self-checkout

  • store layout

• Home delivery

All of these increase barriers of entry - less firms to compete with - easier to retain consumer loyalty

Collusion

= anti-competitive behaviour where rival firms collaborate for mutual benefits through ‘price-fixing’

Types of collusion (overt & tacit collusion)

• Overt (open)

  • formal arrangement to fix prices, output, marketing

  • illegal

  • Extreme form known as ‘cartel’

• Tacit (unspoken)

  • informal, unwritten arrangement

  • illegal, but hard to prove

  • Rival firm(s) have to accept profit max price set by dominant firm to avoid price war as would lose

price war

firms react to another firm’s price cuts by cutting own price

Conditions to make collusion easier

• oligopoly

• Demand reasonably predictable - inelastic demand

• firms communicate well & trust each other

• therefore, can you game theory to depict collusive decisions