Oligopoly- Micro Economics A2

Reasons for non price competition

-Aims to increase the loyalty to a brand, which makes demand for a good more price inelastic. -Brands are used to differentiate between products. If firms can increase brand loyalty, demand becomes more price inelastic. Increasing brand loyalty means firms can attract and keep customers, which can increase their market share. -For example, firms might improve the quality of their customer service, such as having more available delivery times. They might keep their shops open for longer, so consumers can visit when it is convenient. -Special offers, such as buy one get one free, free gifts, or loyalty cards, might be used to attract consumers and increase demand. -Advertising and marketing might be used to make their brand more known and influence consumer preferences. However, it is difficult to know what the effect of increased advertising spending will be. For some firms, it might be ineffective. This would make them incur large sunk costs, which are unrecoverable.

Oligopoly characteristics

-Few dominant firms but smaller firms too, shown by concentration ratio, less competition -The dominant firms have market power -Barriers to entry- less competitive -Interdependence, the action of one firm is affected by the behaviour of the others, this means that there is uncertainty. Not sure how firms will react to conduct. -Product branding: Each firm in the market is selling a branded product. Differentiated E.g. Supermarket industry. Top 5 firms- 77.3% of market share. Tesco 28.1%. Smaller independents as well. There is no single theory of price and output under conditions of oligopoly. If a price war breaks out, oligopolists may choose produce and price much as a highly competitive industry would; whereas at other times they act like a pure monopoly.

Advantages of oligopoly

-Oligopolies can earn significant supernormal profits, so they might invest more in research and development. This can yield positive externalities, and make the monopoly more dynamically efficient in the long run. There could be more invention and innovation as a result. Moreover, firms are more likely to innovate if they can protect their ideas. This is more likely to happen in a market where there are high barriers to entry. -Higher profits could be a source of government revenue. -Industry standards could improve. This is especially true in the pharmaceutical industry and for car safety technology. This is because firms can collaborate on technology and improve it. It saves on duplicate research and development. -Since oligopolies are large, they can exploit economies of scale, so they have lower average costs of production.

Conditions necessary for collusion/ cartel to operate successfully.

-Similar product- oil -A small number of firms in the industry and barriers to entry to protect the monopoly power of existing firms in the LR. -Market demand is not variable (cyclical) i.e. it is reasonably predictable and not subject to violent fluctuations with may lead to excess demand or supply. Problem for OPEC as it may be hard to control output. -Demand is fairly inelastic with respect to price so a higher cartel price increases TR, easier when product is a necessity. -Each firm's output can be easily monitored. Enables cartel to more easily identify total supply and identify firms who are cheating on output quotas.

Disadvantages of oligopoly

-The basic model of oligopoly suggests that higher prices and profits and inefficiency may result in a misallocation of resources compared to the outcome in a competitive market. -If firms collude, there is a loss of consumer welfare, since prices are raised and output is reduced. Loss of consumer, gain of producer surplus, some not redistributed. -Collusion could reinforce the monopoly power of existing firms and makes it hard for new firms to enter. The absence of competition means efficiency falls. This increases the average cost of production.

Competition and Markets Authority can prosecute monopolies

2 Pharmaceutical companies. Actavis, sole supplier of drug payed off Concordia to not launch own version of drug. This enabled them to monopolise the market and charge a higher price to the NHS. Price raised by 12000%.

Cartel/ price ring Name comes from drug gangs agreeing to stay out of each others territory

A cartel is a group of two or more firms which have agreed to control prices, limit output, or prevent the entrance of new firms into the market. A famous example of a cartel is OPEC, which fixed their output of oil. This was possible since they controlled over 70% of the supply of oil in the world. This reduces uncertainty for firms, which would otherwise exist without a cartel. Cartels can lead to higher prices for consumers and restricted outputs. Some cartels might involve dividing the market up, so firms agree not to compete in each other's markets. This enables firms to enjoy supernormal profit. By being protected from competition, cartels display the disadvantages of monopoly, high price, low output. However, this is without benefits- economies of scale and improvements in dynamic efficiency.

Factors which influence output

Collusion/ cartel or a non collusive oligopoly where there is price competition.

Collusive oligopoly

Collusive behaviour occurs if firms agree to work together on something. For example, they might choose to set a price or fix the quantity of output they produce, which minimises the competitive pressure they face. Uncertainty facing competitive oligopolists can be reduced and perhaps eliminated by working together and forming a cartel.

Difference between collusion and cooperation

Cooperation is allowed in the market, whilst collusion is not. Collusion is usually with poor intentions, whilst cooperation will be beneficial. Collusion generally refers to market variables, such as quantity produced, price per unit and marketing expenditure. Cooperation might refer to how a firm is organised and how production is managed. May be ensuring health and safety standards across and industry.

Factors which influence expenditure on advertising

Degree of non price competition.

Open Collusion

E.g. Oil with OPEC, no international laws, not in interest of those countries to have collusion laws. Can breakdown, countries may disagree or break agreement. Makes OPEC like a monopoly. Open collusion can be legal and beneficial. Cooperation to improve health and safety in the industry or that labour standards are maintained.

Significance of interdependence and uncertainty in oligopoly

Encourages firms to collude which can lead to less competition.

Non collusive oligopoly

Firms act independently, do not form agreements with each other. Occurs when the firms are competing. This establishes a competitive oligopoly. This is more likely to occur where there are several firms, one firm has a significant cost advantage, products are homogeneous and the market is saturated. Firms grow by taking market share from rivals.

Oligopoly as a market structure

Firms can operate in a market which is oligopolistic. Hard to define a 'few' firms. Concentration ratio varies, as does number of firms.

Reasons for barriers to entry

Firms might try to drive competitors out of the industry in order to increase their own market share. Barriers to entry are designed to prevent new firms entering the market profitably. This increases producer surplus.

Tacit collusion

Firms undertake actions that are likely to minimise a competitive response. E.g. Avoiding price cutting or not at tracking each other's markets. Unspoken but known.

First mover advantage

First entrant into a particular market.

Criticisms of kinked demand curve

In real world, firms will test the market by raising or lowering price to see how rival firms react in the expected way. If rivals do not, D curve inaccurate. Oligopoly prices tend to be sticky when demand conditions are predictable or cyclical. But oligopolists will usually raise or reduce prices by significance amounts quickly when production costs change substantially or when demand changes unexpectedly.

Concentration ratio

Market share of biggest firms. E.g. 3 firm concentration ratio measures total market share of 3 largest firms.

First scaler advantage

May be more important than first mover advantage in the long run. Key is to get up to scale and become competitive.

Kinked demand curve is not the only

Model of oligopoly. Illustration of interdependence between firms.

Reasons for price wars

Occurs when rival firms continuously move to undercut each other or even force rival firms out of competition. Occur in oligopoly and monopolistic competition. May be started accidentally or deliberately to damage competitors. Consumers can benefit in the SR but in the LR monopoly may form. Firms do it in order to gain market share.

Collusion allows

Oligopolists to act as monopolists and maximise their joint profits. Collusion leads to a lower consumer surplus, higher producer surplus, higher prices and greater profits for the firms colluding. Firms therefore have a strong incentive collude. More likely to happen where there are only a few firms, they face similar costs, there are high entry barriers, it is not easy to be caught and there is an ineffective competition policy. Makes market more stable.

Reasons for price agreements

Same reasons for cartels/ collusion.

Closed collusion

Secret. In most western countries it is illegal due to competition laws. Competition and Market Authority. Bad deal for customers due to collective monopoly.

Reasons for price leadership

Setting of prices in a market, usually by a dominant firm, which is then followed by other firms in the market. One firm acts as a benchmark. This can occur because agreements to fix the market price such as cartel price is usually illegal, firms will use tacit ways to coordinate pricing decisions. This explains why there is price stability in an oligopoly; other firms risk losing market share if they do not follow the price change. The price leader is often the one judge to have the best knowledge of prevailing market conditions.

Oligopoly as a market conduct

Several firms can display oligopolistic behaviour. Firms which display oligopolistic behaviour might be interdependent, have stable prices, collude or have non-price competition.

Factors which influence Investment

Supernormal profit.

Factors which influence expenditure on R and D

Supernormal profit.

As a result of kinked demand curve

The effect of interdependence and uncertainty can be shown by the kinked demand curve. The safest option is for firms to leave price unchanged. Other options to increase revenue will be huge marketing spending on promotions or advertising and persuading customers about product differentiation. There is therefore a temptation to collude in order to reduce uncertainty.

Whistle blowing

When one or more agents in a collusive agreement report it to the authorities.

Factors which influence prices

Whether oligopoly acts as monopoly or competitive market.