23.11.

2022

Market Structures: Oligopolies

Characteristics

Small number of sellers so that any seller’s change in prices can affect the others and many buyers

Can be same or differentiated products

High Barriers to Entry

Price between Perfect Competition and Monopoly

Can keep some supernormal profits in the long run

Complex due to reactions: Kinked Demand Curve (Demand made of two demand curves)

Elastic for price increases and inelastic for price decreases

Price Takers for initial market price, do have some limited price maker abilities for decreases in price

Theory behind Kinked Demand Curve Theory

If one firm increases its price, others won’t follow suit and the initiating firm sees a large decrease in
Quantity Demanded.

If one firm decreases its price, the firm that initiated the price increase won’t see a large increase in
Quantity Demanded.

Key Concepts

Cartel: Association of businesses or countries that collude to influence production levels and thus
the market price

Collusion: takes place when rival companies cooperate for their mutual benefit

Kinked Demand Curve: Assumes that a business faces a dual demand curve for its product based on
the likely reactions of other firms

Interdependence: where the decisions made by a business cannot be taken in isolation, it must
consider the likely reaction of rival firms

Price Leadership: when one firm has a dominant position and firms with lower market shares follow
the price changes of the leader

Prisoners’ Dilemma: problem in game theory that demonstrates why two people might not
cooperate even if it is in their best interests

Definition of Oligopoly

Can be defined as a Market Structure (with few dominant firms, there will be high barriers to entry
and the products will be differentiated) or in terms of conduct and how they behave
(interdependent and can be collusive or competitive)

Rule of Thumb is that the top 5 firms make up at least 60% of the market.

Concentration Ratios
Made up of the market share held by each firm

N is the number of firms

Unbranded/Others don’t count in concentration ratios

Examples

Cinema Market, Petrol Market

Characteristics

Few large firms dominate

High concentration ratios

Each firm supplies branded products

High barriers to entry/exit

Interdependent strategic decisions by firms

Meaning of Interdependence

If few sellers, each firm is likely to be aware of the actions of the others.

Decisions of one firm’s influence, and are influenced by, the decisions of other firms.

This causes oligopolistic industries to be at high risk of tactic or explicit collusion which can lead to
anti-competitive behaviour.

In oligopoly, there is a high level of uncertainty due to unknown factors of other firms’ decisions.

Kinked Demand Curve Theory

Rivals will not follow a price increase by one firm, so the acting firm will lose market share (likely to
be relatively elastic)

Rivals are assumed to be likely to match a price fall by one firm to avoid loss of market share (likely
to be relatively inelastic).

No incentive to change price (either increase or decrease)

Kinked Demand Curve IS NOT OFFICIALLY IN SPECIFICATION (But still get marks)

Effects on the Market from Kinked Demand Curve Theory

Price-Setting power but may be reluctant to use it – rivals unlikely to match a price rise and rivals
likely to match price fall – if a firm is settled on one price, there may be little point in changing it –
even if costs change we often see price rigidity/stability in an oligopoly – this increases the
importance attached to non-price competition (innovation, quality including after-sales, free
upgrades to products, exclusivity/loyalty schemes, branding, sales promotion)

First Move Advantage: first company to sell the product gain automatic market share BUT in the long
run, lose market share

Price Wars
Real World Examples of Price Wars: Low-Cost Airlines, Supermarket Petrol Retailers, Mobile Phone
Tariffs

Winners: Regular Consumers, Managers (Higher sales so may increase bonuses or reach targets)

Losers: Shareholders (Lower profits decrease dividends), Suppliers (may be squeezed – output more
or decrease prices from suppliers)

Long Term Tendency towards Oligopoly

Economies of Scale – large minimum efficient scale

Mergers (Agreement/Horizontal integration [same level]) and Takeovers (Buying Out/Hostile) –

consolidation of industries through acquisitions

Rise of dominant brands in the industry – high rates of profits and barriers to entry

Oligopoly and Collusion

Collusion

A form of anti-competitive behaviour

Horizontal: Same level

Vertical: between Sector (Primary, Secondary and Tertiary)

Explicit is agreed while Tacit is informal agreements through observation

Businesses in a cartel recognise their mutual interdependence and act together to aim towards
maximising joint profits.

Collusion lowers the costs of competition e.g. wasteful marketing wars which can run into millions of
pounds.

Collusion reduces uncertainty in a market leading to higher profits increasing producer surplus and
shareholder value leading to higher share prices

Legal Collusion

Not all instances of collusive behaviour are deemed to be illegal by the European Union Competition
Authorities.

Practices are not prohibited if the agreements ‘contribute to improving the production or
distribution of goods or to promoting technical progress in a market’

1. Development of improved industry standards of production and safety which benefit the
consumer
2. Information sharing designed to give better information to consumers
3. Research joint ventures/know-how agreements, which seek to promote innovative and
inventive behaviour in a market (Promotes R&D to help overall improve the sector’s
technology and machinery)

Price Fixing

 Industry regulators are weak/ineffective

 Penalties for collusion are low relative to potential gains in revenues/operating profits
 Participating firms have a high percentage of total sales allowing them to control market
supply
 Firms can communicate well and trust each other and have similar strategic objectives
 Industry products are standardised and output is easily measurable
 Brands are strong so that consumers will not switch demand when collusion raises price