3.4.4 Oligopoly

Characteristics of oligopoly

• few large, interdependent firms

• Similar products, use brand loyalty through strong advertisements to make products less similar - brand loyalty amongst consumers is strong

• Imperfect knowledge about rival’s price & output decisions

• High barriers to entry/exit - advertising, special offers, sunk costs (irretrievable costs - cost that is hard to get back once leave industry)

• Price-makers - may collude to fix price

• Profit max

Calculation of n-firm concentration ratios & their significance

Significance:

• 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

Examples of oligopoly

• low cost airline

• commercial banks

• cinemas

Types of price competition

• predatory pricing

  • set price below costs to drive existing competitors (rivals) out of market - hard for rivals to match the price

  • When AR less than AC - sub-normal profit

  • When competition is removed, raise price

  • illegal

• Limit pricing

  • set price at a level potential new firms cannot achieve

  • ie. smaller firms unable to achieve same economies of scale

In either case, outcome likely to be lower profits & less appealing. Therefore, collusion is another way - higher profits & more appealing

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 - would not win price war

When is collusion more likely to be successful