4.1.5.5 - Oligopoly

Characteristics of an Oligopoly

• A few large firms

• Somewhat high barriers to entry

• Interdependent - actions of one firm provoke counter-action by others

• Supernormal profit in the long run

• Objectives of firms to profit-maximise

Collusive Oligopoly

Where firms agree to work together in order to improve their mutual objectives and profits - Maximise their “joint-profit'“

Tacit Collusion =

Where firms agree to work together but without any explicit or written agreement.

e.g. price leadership

Cartel =

A collusive agreement by firms usually to fix prices, regulate supply or restrict new entrants.

They are illegal

Collusive Diagram

When firms collude, we can treat the whole market as thought it is a monopoly.

Non-collusive/competitive Oligopoly

Where firms act independently of each other, act competitively by aiming to gain market share at other firms’ expense

• Price wars, non-price competition

Non-Collusive Oligopoly Diagram

Kinked Demand Curve

• If a firm lowers prices (P1 to P2), competitors will simply match this by reducing prices too → so demand is inelastic → Firms lose revenue so MR curve is negative

• If a firm raises prices (P1 to P3), competitors will not follow but keep prices the same → so demand is elastic → Firms lose revenue as large fall in sales

Potential Advantages of Oligopolies

• Greater price stability

• More dynamically efficient

• Cooperation on industrial standards or product features

Disadvantages of Oligopolies

• Allocative inefficiency

• Productive inefficiency

• Higher prices & lower output

• Higher concentration reduces consumer choice

Concentration Ratio

The percentage of market share taken up by the ‘n’ largest firms in an industry (e.g. 3 firm concentration ratio)

Non-Price Competition

Competition between firms in ways other than changing prices

• Quality of product

• Branding

• Customer Service

• Location

• Advertising

• Range of products

Real World Application of Oligopolies - Supermarket Industry

Supermarket Industry

• 5 firm concentration ratio: 66% (Tesco 28.5%)

• Predatory Pricing: 1996 Supermarket price war resulted in 3p baked beans

• Brand loyalty: Over 22mn households use a clubcard in the UK (non-price competition)

• Environment: UK supermarkets produce 240,000 tonnes of food waste annually from their operations and 100,000 tonnes of this is deemed to be edible food.