3.4.4 Oligopoly Flashcards
(20 cards)
How to calculate n-firm concentration ratio?
- Market share of n largest firms in an industry
- Can be calculated on basis of shares in output or shares in employment
e.g. three-firm CR = market share of 3 largest firms in industry
Drawbacks of calculating concentration ratio on basis of shares in employment?
Largest firms in industry may be more capital-intensive in their production methods = share of employment in industry < share of output
Oligopoly market definition?
A market with just a few sellers where the firms are interdependent
Characteristics of oligopoly market?
- Few large firms
- High barriers to entry
- Products can be differentiated or homogenous
- Mutual interdependence between firms
High barriers to entry characteristic for oligopoly market?
Economies of scale - makes it difficult for new firms to compete due to high costs (e.g. aircraft industry, patents, control of natural resources)
High start-up costs - enormous sums spent on product differentiation and advertising by existing firms = difficult for new firms to match such expenditures
Mutual interdependence characteristic for oligopoly market?
- Decisions by one firm affect other firms in industry so interdependent
- Firms are keenly aware of actions of rivals
- Leads to strategic behaviour and conflicting incentives
Strategic behaviour in oligopoly market?
Plans of action that takes into account rivals’ possible courses of action
Conflicting incentives in oligopoly market?
- Firms in oligopoly face incentives that conflict with each other
- Incentive to collude
- Incentive to compete
Incentive to collude in oligopoly market?
- Refers to an agreement between firms to limit competition by fixing price and lowering Q produced
- Reduces uncertainties, maximises profits
Collusion is illegal and gets fined by CMA (apart from OPEC)
Incentive to compete in oligopoly market?
Firms face incentive to compete with rivals to capture portion of rivals’ market shares and profits
Prisoner’s dilemma?
Shows how two rational decision-makers use strategic behaviours to maximise profits by guessing their rival’s behaviour but may end up being collectively worse off
Final position = Nash equilibrium
What does that Nash equilibrium show?
Conflict between pursuit of self-interest and collective firm interest
Firms could be better off by cooperating, trying to make themselves better off ends up making them and rival worse off
Open collusion in oligopoly markets?
Cartel is a formal agreement between firms in an industry
Key objective is to limit competition, increase monopoly power and increase profits
Examples of open collusion?
OPEC
* Each member country assigned a quota - restricted quantity = higher price of oil = higher profits
What factors make it difficult for a cartel to be established and maintained?
- Incentive to cheat
- Cost differences between firms (different cost curves means price difficult to set)
- Number of firms (larger the number = more difficult to arrive at an agreement)
- Possibility of a price war
- Recessions
- Potential entry into the industry (needs high barriers)
- The industry lacks a dominant firm (e.g. Saudi Arabia in OPEC)
Tacit collusion definition?
Examples of types?
Implicit cooperation between firms that is informal
Price leadership, limit pricing
Objectives of tacit collusion?
Same as open
Coordinates prices, avoids price wars, limits comp., reduces uncertainties = increased profits
Price leadership?
Type of tacit collusion
Dominant firm sets a price and initiates any price changes - remaining firms are price takers
e.g. US steel
Obstacles to price leadership?
- Cost differences between firms
- Not all firms may follow the leader
- Firms still face incentive to cheat
- High industry profits = attracts new firms = price leadership agreement endangered
- May not be legal
Limit pricing?
Disadvantage for firms?
Informal agreement to set price lower than profit-maximising = less profit = discourages new firms from joining industry
(Have to sacrifice profit)
