Oligopoly 3.4.4

What are key characteristics of an oligopoly?

• Few dominant firms

• Interdependence: firms closely monitor and react to each other’s actions.

• Barriers to entry

• Non-price competition

What kind of market concentration does an oligopoly have?

High level of market concentration

When does an oligopoly exist?

When the top 5 firms in the market account for more than 60% market shares.

What is market share?

The proportion of total revenue in a market accounted for by a brand, product or company.

What does the concentration ratio measure?

It measures the combined market share of the top ‘n’ number of firms in the industry.

What are the two most common values of ‘n’?

• 5

• 3

What are barriers to entry in an oligopoly?

• economies of scale (cost asymmetry)

• vertical integration

• brand loyalty

• control of important platforms

• expertise, goodwill and reputation

• patent protection

What is meant by interdependent behaviour?

Refers to the fact that the decisions of one firm impact on the decisions of other firms in the market.

What is the effect of interdependent behaviour on the market?

Creates a competitive environment which makes the market less predictable and volatile.

What is meant by non-price competition?

Refers to the use of other competitive strategies to gain an advantage over rivals.

What type of strategies are used in non-price competition?

• advertising/ branding

• product innovation

• product differentiation

• improving customer service

• quality of service, including after-sales

• free upgrades to products

• exclusivity/ loyalty schemes

Why might non-price strategies become more important in oligopolies?

Price competition may not be as effective due to small number of firms and the interdependence between them, making non-price strategies more important.

What are some types of product branding?

• product brand

• service brand

• umbrella brand

• corporate brand

• own-label brand

• global brand

What is a product brand?

brands associated with specific products.

What is a service brand?

add perceived value to services.

What is an umbrella brand?

assigned to more than one product

What is a corporate brand?

promoting the brand name of a business

What is an own-label brand?

type of corporate branding where retail outlets assign branding to a range of goods and services.

What is a global brand?

the ultimate brand- ‘household’ names based on familiarity, availability and stability that are effective across global markets.

When does collusion take place?

When rival companies in an industry cooperate for their own mutual benefit.

What type of collusion is a common business behaviour in an oligopoly and duopoly?

price-fixing

Why is collusion illegal in some countries?

It is a type of anti-competitive behavour.

How does collusion reduce competition in the market?

They set higher prices and limit output.

What is the differences between collusion and cooperation?

• Collusion is an illegal activity in which firms work together to manipulate the market.

• Cooperation is legal and refers to firms working together to achieve mutual benefits in a way that does not harm consumers or the market.

What is tacit collusion?

Type of collusion that occurs when firms don’t explicitly agree to collude, but instead they act in ways that suggest they are colluding.

What is one example of tacit collusion?

Price leadership- when one firm takes the lead in setting prices, and the other firms follow suit.

What are 4 aims of price fixing?

• Main aim to increase profits for all firms involved.

• Ensure they don’t compete on price- more stable and predictable market.

• Keep new entrants out of the market- low prices can be difficult to match.

• Joint profit maximisation.

What are some advantages of Oligopoly's?

• lead to price wars- increase consumer surplus.

• battle for market share leads to higher research and development- improve dynamic efficiency.

• dominant firms can exploit internal economies of scale- leads to lower average costs and lower prices in the long run.

• high supernormal profits can be taxed- source of revenue to help fund key public services.

What are some arguments against oligopoly?

• Cartel behaviour leads to higher prices, causing a loss of allocative efficiency and hurting low income households.

• High concentration ratio limits consumer choice and barriers to entry may deter innovative smaller firms from profitable entry.

• Persuasive advertising can manipulate preferences and distort the allocation of the price mechanism.

• Many transnational oligopolies avoid paying tax through shadow or transfer pricing leaving a government with less money to spend.

What is game theory?

A branch of mathematics that studies strategic decision making.

What is game theory used for?

To analyse the behaviour of businesses in oligopolies and other market structures, as well as in other fields like politics.

What is the Nash equilibrium?

A solution concept in game theory that describes the optimal outcome for all players in a game, given their opponents strategies.

What does the Nash equilibrium help explain?

Explains how rational actors behave in situations or conflict or cooperation, this helps us understand the logic behind seemingly irrational decisions.

What is the cooperative outcome?

An equilibrium in a game where the players agree to cooperate when making decisions.

What is the dominant strategy?

When a single strategy is best for a player regardless of what strategy other players in the game decide to use.

What is tacit collusion?

Where firms undertake actions that are likely to minimise a competitive response, such as avoiding price-cutting or not attacking each other’s market.

What is whistle blowing?

When one or more agents in a collusive agreement report it to the authorities perhaps in hope of lenient treatment.

What is the Zero sum game?

An economic transaction in which whatever is gained by one party must be lost by the other. Net gains are zero.

What is the prisoners dilemma?

A game that illustrates why it is difficult to cooperate, even when in the best interest of both parties. Both players are assumed to select their own dominant strategies, eventually they reach an equilibrium which results in both being worse of than if they were to agree to an alternative (non dominant) strategy.

What can cause price wars to happen?

• Collapse of an existing price-fixing cartel agreement.

• Perception that some existing firms are pricing too high making high supernormal profits.

• Desire to win market share off rivals (zero sum game)

• Entry of new firms/ challenger brands into the market

• Managerial motives- if price cuts increase total revenue- managers willing to go for market share at expense of operating profits.

• Response to external factors such as falling demand in a recession.

How are consumers effected by price wars?

As oligopolies compete on price, they will lower prices and offer more competitive deals to consumers, this causes consumer surplus.

What is meant by ‘predatory pricing’?

Oligopolies will sometimes set their prices artificially low to drive competitors out of business, once the competitors are gone the oligopoly can raise prices, harming customers.

What is meant by ‘race to the bottom’?

Competing on price at the expense of quality.