3.3 Monopoly and oligopoly

Question 1

What are the characteristics of an oligopoly?

Answer 1

• High market concentration
• High barriers to entry
• Top five firms account for over 60%% of ratio
• Price rigidity, non price competition, interdependent decision, attempts to collude and fix prices

Question 2

What are the key assumptions?

Answer 2

• Dominated by few large firms with large market shares
• High market concentration
• Each firm suppplies branded products, differentiated and strong brand loyalty
• High barriers to entry/exit
• Interdependent decision by firms
• Price makers, may collude

Question 3

What is interdependence?

Answer 3

• One firm’s output and decisions influenced by likely behaviour of another
• Few sellers means each firm likely to be aware of actions of others
• Decisions are influenced by other firms
• Oligopolistic industries at risk of tacit or explicit collusion
• In oligopoly always high level of uncertainty

Question 4

What is the concentration ratio?

Answer 4

Combined market share of top n firms in the industry, often 5 or 3 - if 5 firm greater than 60% it is an oligopoly

Question 5

What is non collusive behaviour in an oligopoly?

Answer 5

Innovation, quality of services, upgrades of products, sale promotion, advertising, loyalty schemes

Focus on quality of product, design look and feel, environmental impact, after sales services, other marketing factors such as branding and advertising

Question 6

What are the reasons for collusive behaviour?

Answer 6

• Recognise interdependence and act together to maximise joint profits
• Lowers cost of competition
• Reduces uncertainty

Question 7

What is legal collusion?

Answer 7

• Practices not prohibited if contribute to improving production or distribution of goods
• Development of industry standards benefit consumer
• Information sharing gives better information to consumers
• Research joint ventures and agreements promote innovation and inventive behaviour in a market

Question 8

What is overt collusion?

Answer 8

• Spoken or traceable collusion where they openly work together and agree on prices - rare as CMA prevent this and see high penalties if found out.
• Desire to achieve joint profit maximisation in a market or prevent instability
• Price fixing attempts to control supply and fix price at a level close to monopoly levels
• Producers need control over supply to agree a price.

Question 9

What is tacit collusion?

Answer 9

Firms observe each others behaviour closely and match prices without communication, may emerge over time and be done through price leadership as one firm may take the lead in setting the prices.

Question 10

Why may cartels happen in an oligopoly?

Answer 10

• Industry regulators ineffective
• Penalties for collusion are low
• Few firms in market had inelastic demand - higher prices higher revenues
• Firms have high percentage of total sales so can control market supply
• Firms communicate well and trust each other
• Products standardised and output within cartel easily measurable so supply can be control
• Brands strong so consumers do not switch when collusion raises prices
• Strong barriers preventing consumers to switch to alternatives?

Question 11

Why do cartels break down?

Answer 11

• Enforcement problems - aims to restrict production to maximise profits but each seller finds it profitable to expand production
• Other firms sell under cartel price
• Falling market demand e.g. recession
• Entry of non cartel firms

Question 12

What are the costs and benefits of collusive behaviour?

Answer 12

Costs:

• Damages consumer welfare - high prices, low consumer surplus, loss of allocative efficiency, more inequality
• Lack of competition reduces efficiency - X inefficiency, less incentive to innovate, output quotas penalise firms who want to expand
• Reinforces cartel’s monopoly power

Benefits:

• General industry bring social benefits - pharmaceutical research, safety
• Fairer prices for producer helps lower and middle income developing countries - compete more effectively with powerful corporations with monopsony power
• Profits have value - R&D and higher wages for employees

Question 13

What is game theory?

Answer 13

A model that assesses the behaviour of businesses in oligopolistic markets. For instance, firms may decide to raise output or lower output, considering firm A and firm B.

For instance, if firm A and firm B both choose not to change output, both indexes remain at 100

If firm A decides to raise output but firm B does not, the index of firm A will rise to 130 but firm B will fall to 40 - and vise versa if B rises and A does not

If both decide to rise outputs, then both outputs go to 70 so both lose out

Question 14

Is game theory relevant?

Answer 14

• Analysing business decision making when there are few firms
• Standard game theory assumes rational agents looing to maximise self interest
• More complex theory reveals businesses develop cooperative and collaborative behaviour and rise of joint ventures
• Game theory over simplifies complex decisions - when there are more than two rival firms the complexity increases
• Many firms fall back on rules when making decisions and other decisions

Question 15

What is the kinked demand curve?

Answer 15

As firms anticipate actions of other firms, the demand curve has a kink as there is a point where when if one firms decides to cut costs and others follow, it will create an inelastic segment of the demand curve which could have previously been elastic.

This leaves firms with the dilemma as if they choose to increase prices it will be more inelastic so they may see profit but also consumers may just switch - if they choose to cut prices it is also inelastic so will not see profit wanted.

Question 16

What are the characteristics of monopolies? What are the causes?

Answer 16

• Single supplier dominates the entire market
• Working monopoly is greater than 25% of the industries total sales
• Dominant firm has at least 40% market share
• Price making power available to any business, downward sloping demand curve
• High barriers to entry and exit
• Aim to maximise profit
• Firms are price markers so downward sloping demand
• IF AR falling, MR is below AR.
• Assumed supernormal profits
• MR=MC - controls prices so either reduces price or increases price by reducing sales

Caused by high barriers to entry, lack of product differentiation and near competitors

Question 17

What is a natural monopoly?

Answer 17

Large businesses can supply a market at a lower price than smaller ones. There cannot be more than one efficient provider of a good - an industry where the MES is a large share of market demand.

-Increasing returns to scacle at all levels of output, LRAC drifts lower as production expands - is falling as MC always below LRAC - room for only one supplier to fully exploit EofS

Question 18

What is the impact of reducing competition?

Answer 18

Consumer surplus falls as prices move up, causing welfare loss and increases producer surplus.

Question 19

What are the aims of price discrimination?

Answer 19

_increase total revenue and profits

• Generate cash flow
• Increase marketshare
• More efficiency
• Reduce waste and cut cost of storage

Question 20

What is first and second degree price discrimination?

Answer 20

1st - firms now maximum price consumers are willing to pay so absorb entire consumer surplus, taking it and turning it into revenue - depends on consumer and examples may be using cookies or auctions

2nd - prices vary by quantity sold e.g. bulk purchases or group tickets or peak time prices

Question 21

What conditions are needed for 3rd degree price discrimination?

Answer 21

• Monopoly power - pricing power
• Ability to identify different segments with different elasticities at different price e.g. different times, places, incomes, general PeDs - children vs adults
• Market intelligence on purchasing behaviour of consumers
• Prevention of resale e.g. cinema tickets
• High barriers to entry/exit

Question 22

What is 3rd degree price discrimination

Answer 22

3 curves are created, the market segment, the inelastic (adult) segment and the elastic (student) segment

As the adults have more inelastic demand, they charge higher prices and less is consumed, making more revenue

As the students have more elastic demand, they charge lower prices and more is consumed, making more revenue - the new areas of profits tend should be more than the original profit area beforehand.

It is illustrated on a perfectly competitive market for simplicity

Question 23

What is the impact of price discrimination?

Answer 23

Higher prices for some consumers - loss of consumer surplus and reduction in allocative efficiency, consumer surplus reallocated into producer surplus

• Increases inequality if consumers only access goods and services at higher prices.
• Increased costs to businesses as they have to sub divide costs and check that costs are changed
• Grouping of consumers not perfect - people work around them
• Additional profits may allow incumbent firms to adopt anti competitive practices e.g. predatory pricing, higher entry barriers etc.

Question 24

What are some advantages/disadvantages of price discrimination?

Answer 24

Advantages:
Lower prices for some groups who may not be able to afford otherwise
-More profit for businesses - shareholders and dividends
-Reinvestment and business growth
-Businesses make better use of spare capacity - increased demand in quieter times and reduces overcrowding/excess demand in peak times

Disadvantagse:

• Depends on extent it is used
• How businesses use profits
• Difficult to agree on fair price.

Question 25

What is the case against monopoly power?

Answer 25

• Higher prices lead to loss of allocative efficiency, regressive effect on lower income households
• Absence of genuine market competition lead to production inefficiencies - X inefficiencies
• Higher prices limit output in market lead to fewer EofS exploited
• Protected markets mean less drive to innovate - less dynamic efficiency
• Monopoly may get too big - diseconomies of scale and rising LRAC

Question 26

What is the case for monopoly power?

Answer 26

• Profits fund investment and research
• Natural monopolies use EofS and lower prices
• Domestic monopoly businesses face global competition
• Monopolistic firms regulated
• Price discrimination helps consumers
• Natural monopolies more productively efficient
• Competition in the supply chain so not fully monopoly
• May face significant international competition

Question 27

What is monopsony power?

Answer 27

Sellers face powerful buyers, allowing a firm to exploit its suppliers in the knowledge that the supplier has few options beyond seller to the sole buyers.
The monopsony has buying or bargaining power in the market and so can exploit their bargaining power with a supplier to negotiate lower prices - reduced cost of purchasing inputs increases profit margins

Examples:

• Electricity generators negotiate lower prices for coal contracts
• Food retailers power when buying from farmers
• Low cost airlines get favourable prices when buying aircraft
• NHS dominant buyer of prescription drugs for pharmaceutical companies
• Government major buyer in military stuff

Question 28

What is a pure monopsony?

Answer 28

Sellers face a singular buyer. Monopsonists are able to select profit maximisation point where MC = MR however instead of paying the price the sellers are willing to accept according to this, the monopsonist can bargain the price down to the price equal to their average costs

Question 29

What are the benefits of monopsonies?

Answer 29

Firms achieve bigger purchasing economies of scale leading to lower LRAC
Lower purchase costs, higher profits and increased returns for shareholders
Extra profit used to find capital investment or R&D

Consumers:

• lower prices e.g. supermarkets negotiate better prices from manufacturers
• Improved vale for money - NHS uses bargaining power to cut prices of drugs

Question 30

What are the drawbacks of monopsonies?

Answer 30

• Businesses use buying power to squeeze lower prices out of suppliers - inequality, reduced profits
• Milk farmers tried to get higher price from supermarkets to cover average costs
• Consumers faced with less choice or higher prices in long run if suppliers leave

Question 31

What is the GCA

Answer 31

Groceries code adjustor investigates grocers and take enforcement actions if the code is breached - within department for business, innovation and skills - make recommendations, require information to be published, imposed financial penalties - up to 1% of turnover

Question 32

Supermarket industry?

Answer 32

Tesco 28
Sainsbury 16
Asda 16
Morrisons 11

Externalities
Positive: local markets bigger choice, job opportunities, lower prices lead to higher competition

Negative: pollution of production, congestion in rural areas where setup, rising farm animal prodution, lower price demerit goods

2008 Tesco prevented landlords from letting property to other supermarkets - CMA forced to take action for -land agreements

2008 Sainsbury’s Asda merger blocked by CMA as feared it would raise prices for consumers, raise checkout times and cost of petrol - £7.3bn deal

2021 - 6 supermarkets land agreements reviewed - breaches and reviews of all land agreements

Non price competition:
Advertising
New products and choice
Location and creating new shops
Discounts and loyalty schemes
Online accessibility