More on oligopoly
Firms are interdependent and there is a high degree of uncertainty in the market as a change in one firm's marketing mix may bring about an unknown change in another firms marketing mix.
Collusive Oligopoly
Where firms act together as a single firm to gain monopoly power.
Formal/open agreement
Where firms act together and form a cartel. There is lots of non-price competition within a cartel. Each firm has an allocated output (by market share pre-collusion).
Informal/tacit agreement
Price leadership theories:
Dominant firm price leadership
Where the dominant firm sets the price for the whole industry.
The leader sets a price, PL based on their own MC and MR curves, but taking into account the other firms cost curves. The price needs to be high enough to stop other firms making losses, which would attract the competition commission to investigate the market.
Barometric price leadership
Barometric firm sets the price. The barometric firm is not the largest firm in the market but has better knowledge and ability to forecast the future of the market.
Non-collusive Oligopoly; Kinked demand curve theory
This model assumes
- Non-price competition;
- Two demand curves; and elastic and an inelastic.
The model aims to explain price stability by the use of these two demand curves.
If a firm increases their price
If the firm raises the price from Pe to P1 they will make a net loss in TR so not pursue this pricing policy, assuming the firm is aiming to maximise total revenue, as the pale blue area is larger than the grey area.
If a firm decreases their price
So the price remains constant and stable. This leads to lots of non-price competition within the market.
The two parts of the kinked demand curve have different marginal revenue curves associated with them, so we can draw the following diagram.
Which leads to the kinked demand curve and marginal revenue curve with a discontinuity AB, at the equilibrium output.
If the MC curve fluctuates within the discontinuity AB (between MC and MC’) there is no motivation for the first to change its equilibrium output, assuming the firm is a profit maximising oligopolists.
Oligopolies have advantages and disadvantages. The firm can act against the consumer by reducing consumer surplus, producing a lower quality product, reduce consumers choice and behave in a collusive manner to exploit the consumer as a monopolist.
There is lots of non-price competition so consumers can benefit from better quality products and through technical economies of scale large supernormal profits can be made which can be invested into research and development, so the oligopolists can be advantageous to the consumer.
A capital-intensive oligopolist can have an impact on unemployment within an economy. The labour required by oligopolists is highly specialised which may affect production costs. For example chemical and car industries require lots of capital for production and highly skilled workers to repair machinery and to participate in research and development.
Price Wars
In the short term consumers benefit as they receive a product at a very low price and the consumer feels they are getting a bargain.
Through merger or takeover a monopoly will develop in the long run which is disadvantageous to the consumer.
Hit and run policy
Where a firm enters the market for a short period of time makes supernormal profits then leaves the industry. This can happen in contestable markets.
Contestable market
Contestability is the competitiveness in the market between firms. The following are characteristics of contestable markets.
- Firms are able to diversify (invest in another market area completely outside of their market). This allows firms in a contestable market to
- Reduce or eliminate losses;
- Reduce the risks of production in any one market;
- Increase the chance and size of supernormal profits.
- Low/no barriers to entry.
- 'Costless' exit from the market and entry to the market (there are no non-recoverable or sunk costs such as advertising in a contestable market). This encourages hit and run behaviour from some firms.
- The threat of hit and run, when a firm enters the market for a short period of time, makes supernormal profits, then leaves. The fear of attack from a hit and run firm brings about efficiency in the market as firms aim to suppress the large supernormal profits that attract hit and run firms to enter the market. This threat makes the market act like perfect competition.
Markets can be said to be contestable to a degree as in reality no perfectly contestable market exists, as it is never possible to fully recover costs on leaving an industry, though some industries have very low entry and exist costs as developments in technology improve capital mobility.
Competition policy
The competition commission is a group that encourages contestability through deregulation and tougher competition laws acting against predatory behaviour.
The airline market
- In the late 1990s the European airline market was liberalised, lowering the barriers to entry.
- Traditional firms then faced competition as firms could enter the market more easily.
- New entrants used leased aircraft to keep costs low.
- Firms have merged (such as easyJet and Go in May 2002) to improve the firm’s horizontal integration.
Homework
Read the article given out in the lesson.
These notes are from lessons on 13/10/2004 and 19/10/2004.
