F&D P2: Oligopoly

What is an Oligopoly?

A market dominated by a few large firms with high market concentration. Firms are mutually dependent, have high barriers to entry/exit, and imperfect knowledge. Products can be homogeneous or differentiated.

What is the key distinguishing feature of oligopolies?

Mutual dependence or interdependence.

What is a Dominant Firm? (Oligopoly Characteristic)

A firm with a relatively high market power, commanding a large market share.

What is Market Concentration Ratio?

Measures the extent to which firms dominate the market; sum of market share of X largest firms.

What is Mutual Interdependency (Rival Consciousness)? (Oligopoly Characteristic)

Actions by one dominant firm significantly affect others, triggering rival reactions. Firms must consider rivals' responses when making decisions.

Why is it difficult to predict Oligopoly behavior?

High degree of uncertainty about demand, competitor's costs, actions, and responses. No single theory explains pricing/output.

What is Temptation to Collude/Cooperate? (Oligopoly Characteristic)

Few large firms -> incentive to cooperate to increase profits (form cartels, act like monopoly).

What are Forms of Collusion?

Agreeing on output quotas, fixed prices, limits on promotion/development, or not poaching markets (formal or informal agreements).

What is a Cartel?

Formal collusion where sellers formally agree to maximise joint/industry profits, behaving like a monopolist (determining output and/or price).

What is a Production Quota? (Used by Cartels)

Each firm given a limit on total industry output to maximise joint profits.

Why are Cartel agreements fragile?

Strong incentive for individual members to 'cheat' (produce more than quota) to increase individual profits, leading to breakdown.

What factors affect the effectiveness of cartels? (Factors affecting Cartel Effectiveness)

Few large firms (easier monitoring), standardized products (easier agreement), absence/weak anti-trust laws, stable market demand.

What is Price Leadership Model (Tacit Collusion)?

Informal collusion where unwritten rules of collusive behaviour arise, usually with a dominant firm setting the price that others follow.

What is the Dominant Firm Model? (Price Leadership)

One firm controls vast majority of market share/lowest AC; smaller firms follow its price.

What is the Barometric Model? (Price Leadership)

Firm most adept at identifying market changes and responding efficiently becomes price leader, others follow assuming its awareness.

What is Price Rigidity/Stickiness in Oligopoly?

Prices tend to be rigid/stable because oligopolies prefer non-price competition due to mutual interdependency and fear of rival reactions (price cuts matched, price increases not).

What is the Kinked Demand Theory?

Explains price stickiness in oligopoly: demand is price elastic for price increases (rivals don't follow) but price inelastic for price cuts (rivals match).

What is a Price War?

Suppliers attempt to undercut one another's prices to gain market share/increase total revenue/profits in the long run.

Why are Price Wars unsustainable?

Firms may charge below average cost, leading to subnormal profits and exit. Profits depend on rival reactions.

Why do Oligopolies prefer Non-Price Competition? (Reason for Preference)

To differentiate products, minimise risk of price wars, or avoid price competition due to mutual interdependency and uncertainty.

What are High Barriers to Entry? (Oligopoly Characteristic)

Results in high market concentration and interdependence, allowing oligopolies to retain supernormal profits in the long run.

What are Natural Barriers in an Oligopoly?

Substantial internal economies of scale enjoyed by dominant firms -> new entrants face higher AC, difficult to match prices.

What are Artificial Barriers to Entry?

Strategic barriers (e.g., advertising, R&D, limit pricing, hostile takeovers) and statutory barriers (e.g., patents, copyrights).

What are the Characteristics of Oligopoly? (Summary)

Few dominant firms, mutual interdependency, differentiated/homogeneous products, imperfect knowledge, high barriers to entry/exit.

What is the Profitability of MPC firms? (Summary)

Can make supernormal, normal, or subnormal profits in SR; only normal profits in LR due to low BTE.

What is the Profitability of Oligopolies? (Summary)

Can retain supernormal profits in the long run due to high BTE.