Oligopoly

Drawback of collusion

Seen against the public interest because of higher prices leading to allocative efficiency. There is legislation against collusion and cartels in the UK

Features of a price war

- More likely in a recession when demand is falling and markets become more competitive - Tend to be short term because firms will make a loss otherwise - Often selective which can give a misleading impression of price competition - Can be in the public interest, but only if firms don't get forced out of business by the low prices

Methods of non price competition

1. Advertising - creates product differentiation and brand loyalty 2. Product development - improve quality of products 3. Loyalty cards - creates brand loyalty 4. Quality of service - make demand more inelastic 5. Location - better location picks up more passing trade

Evaluation of collusion

1. Enables higher profits, however if firms are found guilty they can be fined 2. Unlikely to occur if firms aim at sales maximisation 3. Firms may justify it on the grounds that it encourages stability, however firms may actually become inefficient because it is easy to make a profit.

Factors influencing the behaviour of firms in oligopoly

1. Objectives of firms - e.g. profit max or sales max 2. Degree of contestability - e.g. amount of barriers to entry 3. Government regulation 4. The nature of the industry

Features of collusion

1. Small number of firms 2. A dominant firm who is able to have influence in setting the price 3. Barriers to entry 4. Effective communication and monitoring of output and costs 5. No effective government legislation

Cartel

A formal collusive agreement (E.g. OPEC)

Oligopoly

A market structure in which a few large firms dominate a market

Non-pricing strategy: advertising

Aim = to increase brand loyalty Success can also create a barrier to entry HOWEVER: - Depends on the product - ineffective for a product such as petrol because the price will always remain the most important factor - Depends on the quality of advertising

Price competitive / price wars

An oligopoly where firms try to gain market share and where prices and profits tend to be low

Tacit collusion

An unwritten agreement where firms observe informal rules, such as not undercutting rivals. Often occurs if there is government regulation against it

Why predatory pricing is against the public interest

Because the dominant firm can increase prices when its rival has left

Limitations of the kinked demand curve model

Does not explain how prices were set in the first place Price stability may be due to other factors In the real world, firms do not often cut or increase prices Firms may not be profit maximisers, but seek increased market share, even if it means less profit

Example of game theory

If a firm in oligopoly cuts price, the outcome will largely depend on how other firms react, e.g. do other firms follow suit, starting a price war, or do they keep prices high? There is no guarantee

The kinked demand curve model

If a firm increases price, they will lose a large share of the market because they become competitive If firms cut prices, they would gain a big increase in market share. However, it is unlikely that firms will allow this, so other firms follow suit and cut prices as well Therefore, increasing or decreasing prices will lead to lower revenue and therefore prices will be rigid in oligopoly

Higher prices/collusion

If there are barriers to entry, firms may try to maximise profits through increasing prices and this may involve collusion

Features of an oligopoly

Interdependence of firms - firms will be affected by how other firms set price and output Barriers to entry Differentiated products - advertising and non-price competition are often important

Pricing strategy: price cuts

Involves undercutting rivals, through offering cheaper prices If demand is elastic and sensitive to price, this could lead to an increase in sales and an increase in profits HOWEVER - Depends on how other firms react. If it starts a price war, it could lead to lower profits due to lower prices but no increase in sales - Depends on the product - supermarkets sell cheaper cola than Pepsi and coca cola, but they are unable to take market share because there is such strong brand loyalty to the product.

The kinked demand curve model assumes...

That firms seek to maximise profits

Game theory

The behaviour of firms considering how decisions of other firms affect their own choices.

Stable prices / focus on non-price competition

The kinked demand curve suggests that prices will be stable and firms focus on non-price competition

Predatory pricing

When a firm lowers prices in some sections of the market with the intent of forcing another firm out of the business

Collusion

When firms agree to limit competition by setting output quotas and fixing prices

Overt collusion

When firms openly agree on price, output, and other decisions aimed at achieving monopoly profits.

Benefit of collusion

firms are able to maximise profits - there will be a similar price and outcome to a monopolistic industry with firms effectively sharing the supernormal profits