1.5.5: Oligopoly (HL only)

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    Definitions

     

    1. Concentration ratio measure the proportion of the total market share controlled by a given number of firms.
    2. Oligopoly is a market structure where there are a few large firms that dominate the market. A key feature is that of interdependence between firms, and there tends to be price rigidity.
    3. Cartel is a group of firms in an industry that join together to limit competition between member firms, fix prices and maximize joint profits as if the firms were collectively a monopoly. They are usually illegal in most countries.
    4. Non-collusive oligopoly is where firms in an oligopoly don’t resort to agreements to fix prices or output. Competition tends to be non-price and prices tend to be stable, with firms developing strategies that take into account all possible reactions from their rivals when making pricing decisions.

     

    Assumptions of the model

    • Few firms dominate the market.
    • Some firms produce identical or differentiated products.
    • Low barriers to entry.

    Firms are interdependent on each other.

     

    Game Theory

    • Considers the strategy a firm could take in light of decisions by rival firms.

    • When airline A wants to reduce prices, it is assumed that airline B also reduces their price, but that isn’t always the case.
    • When airline B speculates airline A is reducing their prices, prices of airline B drops while airline A stays the same, therefore earning more profit.
    • In order to act as an oligopoly, they would either have to keep the prices their same or reduce their profits, which would then harm the industry.
    • Game theory is only useful when there are small number of firms, small number of possible options and outcomes can be accurately predicted.

     

    Kinked demand curve

    • If the firm raises their price, it is unlikely that the other firms would also raise their price → Loss of demand → Demand becomes elastic.
    • IF the firm lowers their price, it is likely that other firms would follow them and reduce their prices → Loss of sales → Demand becomes inelastic.

    ●       Three reasons for price rigidity

    • Firms are afraid to raise prices above the current market price because other firms won’t follow them → Lose trade, sales and profit.
    • Firms are afraid to lower prices below the current market price because other firms will follow them → Creating a price war that harms all firms involved.
    • If MC rises, MC would still be equal to MR so the firms wouldn’t change their prices or outputs.

     

    Non price competition

    • Firms in oligopoly tend to compete on quality rather than price.
    • Examples of non-price competition includes packaging, brand names, special features, advertising, sales promotion, personal selling, publicity, sponsorship deals and special distribution features.
    • Main aim is to increase brand loyalty and make demand for products inelastic.