Chapter 10: Oligopoly

Different Strategies for Firms in an Oligopoly

1. Both firms are making the same profits and are both considering lowering their prices. Firm A has two choices; leave it's price unchanged, or lower it. 2. If Firm A is pessimistic, it would consider the worst case scenario, in which firm B responds in a way that is most damaging to Firm A. If it does not lower it's price and firm B does, then it's profit would fall considerably. If both firms lower their price, then the revenue of firm A will still fall, but less substantially. The best option, in this case, is to lower prices. The firm is maximising it's minimum profit options, and is therefore known as a 'Maximin' strategy. The strategy is to adopt the policy that has the least worst outcome. 3. If Firm A is optimistic, it might consider the best possible scenarios following it's choices, where Firm B responds in the way that is best for Firm A. If it does not lower its price and Firm B also does not lower it's price, then firm A will maintain it's profits. If Firm A lowers its price and Firm B does not lower its price, then firm A will increase their profits. The best option for Firm A is to lower its price. The strategy of trying to make the maximum profit available is known as the 'Maximax' strategy. Firm A's Maximin and maximax strategies are both to lower price. The same logic applies to the other firm. If both firms adopt the strategy of lowering prices, they will both lower their profits. They would have benefitted from leaving their prices as they were or colluding.

Reasons as to why there is price rigidity in a non-collusive oligopoly

1. Firms are Afraid to raise prices above the current market price, because other firms will not follow, and so they will lose trade, sales, and probably profit. 2. Firms are afraid to lower their prices below the current market price, because other firms will follow, undercutting them, and so creating a price war that may harm all the firms involved. 3. The shape of the Marginal Revenue curve means that if marginal costs were to rise, then it is possible that MC would still equal MR, and so the firms, being profit maximizers, would not change their prices or outputs.

Non-Price Competition

Brand names, packaging, special features, advertising, sales promotion, personal selling, publicity, discounts and other deals etc are forms of non-price competition. Oligopoly is characterized by large advertising and marketing expenditures, as firms try to develop brand loyalty and make demand for their products less elastic. It could be argued that this is a misallocation of resources, but could also be argued that competition among large companies results in greater choice for consumers. Firms undertake al kinds of behaviour to guard and extend their market share, which serves to increase the barriers to entry to new firms.

Collusive Oligopoly

Collusive oligopoly exists when the firms in an oligopolistic market collude to charge the same prices for their products, acting as a monopoly, and so divide up any monopoly profits that may be made. There are two types of collusion; formal collusion and Tacit Collusion. A collusive oligpoly offers an explanation of price rigidity in an oligopoly, as, if firms are colluding, either formally or tacitly, and they are making their share of long-run monopoly profits, then they may try to keep prices stable in order that the situation continues.

Tacit Collusion

Tacit collusion exists when firms in an oligopoly charge the same prices without any formal collusion. A firm may charge the same price as another by looking at the prices of a dominant firm in the industry, or at the prices of the main competitors. It is not necessary to communicate to be able to charge the same prices.

Game Theory

The optimum strategy that a firm could undertake in light of different possible decisions by rival firms.

Assumptions of Oligopoly

When a few firms dominate an industry. The industry's total output is shared by a small number of firms. Concentration in the industry is dependent on concentration ratios, where X represents the number of the largest firms. Oligopolistic industries differ in nature, with some producing identical products and some differentiating their products. In most oligopolies, there are strict barriers to entry, but this is not universal. However, the key feature of oligopolies is their interdependence. As there are just a few firms, each needs to take careful notice of each other's actions, and so they want to collude and act as as a monopoly so they can maximize industry profits. However, in some other oligopolies, firms compete vigorously with each other in order to gain a greater market share. Oligopolies are characterised, also, by price rigidity. Prices in oligopoly tend to change much less than in more competitive markets. Even when there are production cost changes, oligopolistic firms often leave their prices unchanged.

Non-Collusive Oligopoly

When firms in an oligopoly do not collude and have to be very aware of the reactions of other firms when making pricing decisions. It is said that the behaviour of firms in an oligopoly is strategic behaviour, as they must develop strategies that take into account all possible actions of rivals.

Formal Collusion

When firms openly agree on the price that they will all charge, although it may be an agreement on market share or marketing expenditure instead. A collusive oligopoly if this nature is known as a cartel. Since this results in higher prices and less output for consumers, this is usually considered to be against the interest of consumers, and it is usually banned in a number of countries by a country's anti-trust authority.

Duopoly

When there are only two firms which make up a market. This is a hypothetical situation, and it is usually assumed that the firms have equal costs, identical products and share the market evenly, so the initial demand for their goods is the same.