Oligopoly

Evaluation of collusion (depends on factors)

- Collusion enables higher profits. However if firms are found guilty of collusion, they can be fined and so end up with lower profits. - Firms may justify collusion on the grounds that it encourages stability, and the higher profits can be used to finance investment, leading to better products. However, under collusions, firms may become inefficient, because making a profit is easy and they do not have to strive for maximum efficiency. - Collusion will not occur if firms aim at sales maximisation.

Evaluation of Price wars (depends upon factors)

- Depends upon the brand loyalty of other products in the market place, e.g. Coca Cola have such strong brand loyalty cheaper supermarket cola won't be able to take any market share and therefore won't start a price war. - Price wars tend to be short-term since, otherwise, firms will make a loss. - Price wars are more likely in a recession, where demand is falling (consumer income falling) and markets become more competitive. - Price wars can be in the public interest, as long as firms don't get forced out of business by the low prices.

What is predatory pricing (in an oligopoly/monopoly)?

- This occurs when an existing firm lowers prices to force either a new business or another smaller business out of the market. - It involves cutting prices and making a temporary loss in order to force the new/existing firm out of the market. - Predatory pricing is against the public interest, because the dominant firm can increase prices when its rival has left; predatory pricing is illegal.

What is collusion, types of collusion, what are the effects for the businesses and consumers?

-Collusion occurs when firms agree to limit competition, by setting output quotas and fixing prices. - A cartel is a formal collusive agreement. - Tacit collusion is an unwritten agreement where firms observe informal rules, such as not undercutting rivals, this often occurs when there is government regulation against cartels. - Through collusion, firms are able to maximise profits of the industry. There will be a similar price and outcome to a monopolistic industry, with firms effectively sharing supernormal profits. - Collusion is seen as against public interest, because of higher prices leading to allocative inefficiency.

Draw a kinked demand curve, and explain how it explains that firms will not want to change their price.

-Model assumes firms seek to maximise profits. - If a firm increases price, they will lose a large share of the market because they have become uncompetitive compared to other firms, and therefore demand is elastic for price increases. - If firms cut prices, then they should gain a big increase in market, however other firms will in this instance likely follow suit and also cut prices, therefore demand is inelastic for a price cut. - This theory suggests increasing or decreasing prices will lead to lower revenue and therefore prices will be rigid in an oligopoly.

What are some potential negatives of oligopolies?

1) *Collusion* - if an industry is dominated by a few large firms, it increases the risk of collusion; this can lead to a similar outcome as a monopoly with higher prices for consumers without the competitive pressures to cut costs. 2) *Resources wasted on advertising* - the battle for brand loyalty can encourage firms to waste money on advertising. This can lead to higher prices for consumers, without increasing quality of the product. 3) *Creating barriers to entry* - firms in an oligopoly may devote resources to increasing barriers to entry; this can include advertising or building up reserves to execute predatory pricing if a new firm enters the market.

What are factors that favour collusion?

1) A small number of firms, in the industry. 2) A dominant firm who is able to have influence in setting the price. 3) Barriers to entry; this is important to stop new firms entering the market and taking advantage of high profits. 4) No government legislation, e.g. collusion is illegal in the UK, making collusion more difficult.

Evaluation (depends on) factors on whether oligopolies are good or not.

1) Depends on contestability of the market - if an oligopoly is contestable, then it's easy for new firms to enter the market. This will increase the competitive pressure withing the industry and there will be the possibility of hit and run competition to reduce high profit. The internet has enabled greater contestability by reducing entry costs, e.g. internet banking firms in the banking sector. 2) Depends on the industry - some oligopolies are prone to collusion because there's little prospect of new firms entering, e.g. UK cement industry. However, other oligopolies are more competitive competitive and dynamic, e.g. mobile phone market. 3) Depends on firms behaviour - some firms in oligopoly are quite dynamic and efficient, e.g. Google.

What are the benefits of an oligopoly?

1) Economies of scale - firms in oligopoly can benefit from lower average costs, which will lead to lower prices for consumers. 2) More competition than monopoly - Oligopolies can benefit from EOS, but there is still a degree of competition which keeps prices low, e.g. the global car market is competitive despite very high scale of production. 3) Responding to consumer needs - oligopolies often concentrate on non-price competition, e.g. developing new features for phones; this can be more important than price to consumers. 4) Dynamic efficiency - oligopolies can sustainably make supernormal profit, this can be used for development of new products; important in markets like drug industry. 5) Contestable oligopoly - if an oligopoly is contestable with low barriers to entry, then prices will remain low.

What are the three main ways for firms in an oligopoly to compete?

1) Price competitive/price wars - An oligopoly where firms try to gain market share and where prices and profits tend to be low. 2) Stable prices/non-price competition - The kinked demand curve suggests prices will be stable and firms will focus on non-price competition. 3) Higher prices/collusion - If there are barriers to entry, firms may try to maximise profit through increasing prices, this may involve collusion.

What are other (not advertising) examples of non-price competition?

1) Product development - improving the quality of the product, e.g. smartphones with more features. 2) Quality of service - increasing loyalty makes demand more inelastic, through better quality goods. 3) Loyalty schemes - reason for customers to come back.

What are the limitations of the kinked demand curve?

1) The model does not explain how prices were set in the first place. 2) Price stability may be due to other factors. 3) In the real world, firms often do cut or increase price. 4) Firms may not be profit maximisers, but seek increased market share, even if it means less profit.

What does the behaviour of firms in an oligopoly depend upon?

1) The objectives of firms, e.g. profit max or sales max. 2) Degree of contestability, e.g. amount of barriers to entry. 3) Government regulations, e.g. preventing collusion and price fixing. 4) Nature of the industry, e.g. an industry in decline may be more prone to price competition as firms try to retain sales.

Explain why firms in an oligopoly don't reduce prices using game theory (Nash Equilibrium)

A Nash equilibrium is a situation where there is no dominant strategy, i.e. best choice in all scenarios. In the matrix shown, there is equilibrium in situation CC and SS since neither player would choose to change his action given the action of the other one, i.e. changing results in a worse outcome. Situations CS and SC are not in equilibrium since one player would wish to change his action given the action of the other. Once in CS, or SC the other firm will change his action resulting in an SS situation. Therefore if you think of CC as high profit and SS as low profit for both firms, once in CC neither firm has an incentive to change, this explains why firms in oligopoly don't change from a high price and also why firms get stuck in price wars when one firm defects and lowers prices.

Explain the main type of non-price competition and evaluate its importance (in different markets)

Advertising - this creates product differentiation and brand loyalty; if firms are successful with building brand loyalty then consumers will wish to buy the product even at a higher price. Successful advertising can make demand more inelastic and therefore increase profits. Successful advertising can also create a barrier to entry since a new firm may be unable to compete with an advertising budget of an existing firm. Evaluation (depends on factors): The importance of advertising depends on the product, e.g. advertising and brand loyalty can be important for soft drinks or cars, but for a product like petrol where people believe the products are homogeneous then price will always remain the most important factor. It also depends on the quality of advertising, poor advertising can actually diminish a brands image, such as Nike's long-term sponsorship of Lance Armstrong.

What is an oligopoly and what are it's main features?

An oligopoly is where an industry is dominated by a few firms, featuring: - Interdependence of firms: firms will be affected by how other firms set price and output. - Barriers to entry, low contestability (but more than a monopoly) - Differentiated products. Advertising and non-price competition are often important in oligopoly.

Why might price wars happen in oligopolies?

Firms might now seek to maximise profits but have other aims such as increasing market share and expanding the firm; explaining why they seek to reduce prices and start price wars. If demand is elastic and sensitive to price, price cuts could lead to an increase in sales and an increase in profits. This might work for a mostly homogeneous product like petrol.

What does interdependence mean (oligopoly)?

Interdependence means that firms cannot act independently of each other, since if they make a decision they must take into account the reactions of their competitors. E.g. if a petrol retailer wants to increase its market share by reducing price, it must take into account the possibility that close rivals may reduce their price in retaliation.

What is a way of measuring whether an industry is an oligopoly or not?

The three/five/seven firm concentration ratio, add up the market share of the largest firms. One definition of a monopoly is a five firm concentration ratio of more than 50%.

Why might a firm be incentivized to break collusion, and collusion subsequently breakdown?

When the market price is high, if a firm cuts its prices then they have the potential to increase market share massively and make more profit. Once a firm cuts prices, it encourages the other to cut prices and the firms end up with low prices and profit.