Unit 3: Oligopoly Flashcards
What is an Oligopoly?
A market dominated by a few producers, each of which has control over the market
What are the Characteristics of an Oligopoly?
- Supply is concentrated in the hands of relatively few firms
- Firms are interdependent, the actions of one firm affects others in the industry
- Goods may be homogenous or differentiated
- Firms often engage in non-price competition
- There are periodic aggressive price wars
- Firms may collude
- Prices are stable
What are some Examples of Oligopolies?
Energy suppliers Commercial banks Pharmaceutical retailers Mobile phones Soft drink manufacturers Supermarkets
What is meant by the Concentration Ratio?
The concentration ratio measures market share of the top ‘n’ firms in an industry
Shares can be by sales, employment, or any other indicators
How to calculate: Just add it up
What are the coefficients of the Concentration Ratio?
High number - the industry is highly concentrated, and dominated by a small number of firms
Low number - the industry is more highly competitive
What type of Demand Curve does an Oligopoly have?
Kinked Demand Curve
Used to illustrate the behaviour of firms in an oligopoly
It consists of 2 demand curves- elastic demand & inelastic demand
The square/rectangle underneath the equilibrium shows Total Revenue
What would happen if a firm in an Oligopoly Increased the Price of their product?
Elastic Curve:
A firm increases the price
Other firms’ rices haven’t changed
Those demanding that firm’s product will new switch to the substitutes
They lose market share (elastic demand- a price inc. will reduce a lot of demand)
What would happen if a firm in an Oligopoly Decreased the Price of their product?
Inelastic Curve:
A firm decreases the price
To prevent competition and loss in market share, the other firms decrease their prices (price war)
The firm’s revenues decrease (inelastic demand)
Why do prices tend to remain Stable in an Oligopoly?
Total revenue is maximise ‘at the kink’.
If price increases and demand is elastic, total revenue falls.
If price decreases and demand is inelastic, total revenue decreases.
As a result of the above, prices tend to remain stable as firms are reluctant to change prices up or down
What is meant by Collusion?
Collusion represents an attempt by firms to recognise their interdependence, and act together rather than compete.
It is a move towards joint profit maximisation
What is a Cartel?
A cartel is a formal agreement among competing firms
What are the Two Types of Collusion?
Overt Collusion
Tacit Collusion
What is Overt Collusion?
A price-fixing agreement with a producer cartel responsible for allocating output/supply within the market
What is Tacit Collusion?
A dominant firm is the price leader, and others follow
Are Cartels legal or illegal?
Illegal
Firms that operate a cartel can now be fined up to 10% of their UK turnover for up to 3 years
When is Collusion Easier?
Collusion is easier when..
There is only a small number firms in the industry (??)
The industry has substantial high barriers (??)
Firms output can be easily manipulated (??)
Total market demand not too variable
Low YED, Inelastic PED
What is Price Leadership?
Price leadership occurs when one firm changes their prices, and other firms follow.
Other firms are often forced into changing their prices too; otherwise they risk losing their market share.
The price leader is often the 1 judge to have the best knowledge of prevailing market conditions
This explains why there is price stability in an oligopoly
What is Game Theory?
Game theory refers to the interdependence between firms in an oligopoly.
It is used to predict the outcome of a decision made by one firm, when it has incomplete information about the other firm.
What is the Prisoner’s Dilemma?
A model based around two prisoners, who have the choice to either confess or deny a crime.
The consequences of the choice depends on what the other prisoner chooses.
The two prisoners are not allowed to communicate, but they can consider what the other person is likely to choose.
This relates to the characteristic of uncertainty in an oligopoly.
What is meant by the Dominant Strategy?
The dominant strategy is the option which is best, regardless of what the other person chooses.
This is for both prisoners to confess since this gives the minimum number of years that they have to spend in prison.
It is the most likely outcome.
What is meant by the Nash Equilibrium?
(The dominant strategy is still higher than if both prisoners deny the crime.
However, if collusion is allowed in this dilemma, then both prisoners would deny. This is the Nash equilibrium.)
A concept in game theory which describes the optimal strategy for all players, whilst taking into account what opponents have chosen.
They cannot improve their position given the choice of the other.
However: Even if both prisoners agree to deny, it would have an incentive to cheat and therefore confess, since this would reduce the potential sentence from 2 years to 1 year – this makes the Nash equilibrium unstable
What is meant by Price Strategies?
When firms use the price of their product to influence market share.
It’s not very much used, as prices tend to be stable
What are the Types of Pricing Strategies?
Price Wars
Predatory Pricing
Limit Pricing
Psychological Pricing: Giving prices that end in 9; It’s psychologically seen as a separate, cheaper price. (eg 99p vs £1)
Price Skimming: Giving a high price at the launch of a product. Once the top end of the market (those willing to pay the most) has been ‘skimmed’, they lower their prices. iPhones tend to do this.
Price Penetration: Giving a low price initially, in order to gain market share/ customer base/ hope. This tends to occur when the business is targeting a mass market
Loss Leader: When a business sets the price below the cost of the product. This can attract customers to a store, where they will also buy additional products. Some firms sell the core product as a loss leader and make additional sales by selling accessories of the product
What is meant by Non-Price Strategies?
When firms don’t use the price of their product to influence market share. These aim to increase the loyalty to a brand, which makes demand for a good more price inelastic.
These strategies are mainly used within firms in an oligopoly
