Oligopoly

Question 1

n-firm concentration ratio

Answer 1

a measure of the market share of the largest n firms in an industry

tells us the % of the market share captured by the top n firms

Question 2

Oligopoly

Answer 2

a market with a few dominant sellers, in which each firm must take account of the behaviour and likely behaviour of rival firms in the industry

Question 3

non-price competition

Answer 3

a strategy whereby firms compete by advertising to encourage brand loyalty, or by quality or design, rather than on price

Question 4

cartel

Answer 4

an agreement between firms on price and/or output with the intention of maximising their joint profits

(usually illegal)

Question 5

tacit collusion

Answer 5

a situation occurring when firms refrain from competing on price, but without communication or formal agreement between them

Question 6

strategic alliance

Answer 6

a long-term cooperative arrangement between firms, such as sharing networks or bulk buying

often about reducing costs, such as contributing to open-source software, ISO standards, bulk buying (e.g. Tesco/Carrefour) or sharing networks (e.g. Skyteam – AirFrance, Delta and 17 other airlines). But these can risk investigation from regulators.

Question 7

price leadership

Answer 7

a dominant producer sets a price and competitors follow

Question 8

barometric price leadership

Answer 8

a firm tries out a price increase to see if competitors follow, and cuts prices if they don’t

Question 9

How is market share usually calculated

Answer 9

as the % of sales a firm has out of total sales

Market share could also be calculated by:
% of total sales revenue
% of profits
% of employees

If the number of firms in a market falls, the market becomes more concentrated

Question 10

Examples of oligopoly

Answer 10

Supermarkets
Banks
Cinema
Soft drinks

Question 11

5 Characteristics of oligopoly

Answer 11

1. Few large firms
2. High barriers to entry
3. Non-price competition
4. Price makers
5. Interdependent decision making

Question 12

Why does oligopoly have few large firms

Answer 12

the market is dominated by a few sellers gaining from economies of scale

Question 13

Why does oligopoly have high barriers to entry

Answer 13

new entrants can’t easily compete away SNP, and smaller firms can exist but without significant impact on prices and output

Question 14

Why does oligopoly have non-price competition

Answer 14

firms avoid competing on price, but engage in product differentiation in different ways

Question 15

Why is oligopoly a price maker

Answer 15

have the power to set prices

Question 16

Why does oligopoly have interdependent decision making

Answer 16

each takes strategic decisions on price and output based on likely rival actions and reactions

Question 17

Do oligopolies behave like monopolies?

Answer 17

at times, and at others like a much more competitive market

Question 18

What do firms compete with when engaging in non-price competition

Answer 18

1. Innovation
2. Customer service
3. Free upgrades
4. Exclusivity
5. Loyalty schemes
6. Branding
7. (Non-price) sales promotions
8. Convenient location
9. Breadth of product range

Question 19

Why do oligopoly engage in non-price competition

Answer 19

to keep revenues and profits high, as firms do not want to be forced onto the inelastic part of the demand curve

Oligopolies can do this because there being few firms makes tacit collusion possible

Question 20

kinked demand curve

Answer 20

Because there are few competitors, firms try to anticipate the actions of their rivals

This means that firms may compete or cooperate depending on the situation

Oligopolies can assume that if one firm raises prices, because other firms will not, the firm will lose the customers that switch to other firms’ products – lowering profits; demand is price elastic when prices rise

But if one firm lowers prices, other firms follow to avoid losing customers and market share – lowering profits; demand is price inelastic when prices fall

Firms have no incentive to change prices away from profit maximisation, so price stability results

Question 21

kinked demand curve analysis

Answer 21

The kinked demand curve models the behaviour of a firm trying to anticipate the behaviour of its rivals to its actions. The elastic part of the demand curve means a price rise by a single firm above P0 lowers total revenue as competitors will not increase their prices and consumers buy their substitute goods. Furthermore, the inelastic part of the demand curve means a price cut below P0 also lowers total revenue as other firms copy the price cut to retain their market share. This leads to the kink in the demand curve and the discontinuous MR curve. Because MC crosses the vertical part of the MR curve, a change in costs could lead to lower or higher profits for the oligopoly without impacting the level of output, or the price – which is why there is price stability in oligopoly markets. The profit maximising firm will therefore leave price constant, leading to firms engaging in non-price competition.

Question 22

When does collusion occur

Answer 22

when firms cooperate on price or output against the interests of consumers

Question 23

When does price competition occur

Answer 23

when oligopolistic conditions are weaker

1. There is a relatively large number of firms in the market
2. One firm has a cost advantage, and faces lower costs
3. Products are good substitutes for each other
4. There are relatively low barriers to entry

Question 24

Firms in oligopoly can either

Answer 24

compete or collude

Question 25

When does collusive behaviour occur

Answer 25

when oligopolistic conditions are stronger

1. There are relatively few firms in the market
2. Firms have similar costs
3. Product differentiation, particularly brand loyalty, makes non-price competition more viable
4. Barriers to entry are relatively high

Question 26

Analysis of collusion

Answer 26

Collusion, particularly tacit collusion, is more likely to take place in an oligopolistic market with a small number of firms because few firms makes it easier to predict responses of other firms to changes in price and output. Furthermore, if products are similar enough that firms face similar cost conditions it is easier to settle on a price that benefits all firms. Finally, high barriers to entry makes price competition by new firms more difficult as they are less able to gain the economies of scale enjoyed by incumbent firms, especially if incumbents drive out new entrants with predatory pricing.

Question 27

Advantages of oligopoly

Answer 27

1. Could be dynamically efficient

Higher profit levels than a more competitive firm means more scope to invest SNP into R&D. It may choose to develop advanced technology or train workers if it knows this will keep barriers to entry high.

2. Benefits from economies of scale

Few suppliers mean scope for benefiting from economies of scale and achieving a lower average cost. Even making profits, the price charged could be lower than in a more competitive market.

3. Competitive oligopolies raise efficiencies

Output is raised increasing allocative efficiency and competition disciplines the oligopoly lowering the chance of X-inefficiencies

Question 28

Disadvantages of oligopoly

Answer 28

1. Could be x-inefficient

Lack of competition reduces incentive to reduce excessive stock levels or overstaffing, leading to higher prices for consumers and lower utility

2. Could be dynamically inefficient

Lack of competition may mean that it does not reinvest profits to improve the quality of its products

3. Collusive oligopolies raise prices and lower output – economically inefficient

Productive and allocative inefficiency mean that quantity supplied to consumers is restricted, reducing utility, and at a higher price, further reducing consumer utility – an inefficient use of scarce resources

Question 29

Judgement oligopoly compared to monopoly

Answer 29

Better than monopoly because more consumer choice and, if competitive, lower prices

Worse than monopoly because less opportunity to benefit from dynamic efficiencies and economies of scale

Question 30

Judgement oligopoly compared to monopolistic competition

Answer 30

Better than monopolistic competition because more chance of benefiting from economies of scale and can achieve dynamic efficiencies in the long run

Worse than monopolistic competition if a collusive oligopoly because prices are higher and output restricted leading to fewer consumers benefiting and loss of consumer surplus