Concentrated Markets
Content
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Monopoly
Oligopoly
Price makers and price takers
Growth of firms
Sources of monopoly power
Model of the monopoly
Collusive and non collusive oligopoly
Interdependence in oligopolistic markets
Price discrimination
Consumer and producer surplus
Contestable and non contestable markets
Market Structure, Static Efficiency, Dynamic Efficiency and Resource Allocation
Monopolies
• Monopoly – this is where there is a single producer
in the market
• Features:
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One producer is able to charge relatively high prices
New products are rarely introduced
Resources are not used efficiently
Monopolies have market power
Monopolies are able to set prices – price setters
Oligopolies
Few firms in the market who are interdependent in their
actions
– Firms consider competitors reactions when changing prices /
introducing new products
– There is a high degree of competition
– Businesses try and avoid price competition preferring non price
competition
– Products are branded and differentiated from each other
– Can be many take-overs
– Collusion may occur leading to cartels being formed
Price makers and price takers
• In pure monopolies the firm is a price maker as they
are able to take the markets demand curve as their
own
• The monopoly firm is able to set the price anywhere
on this demand curve
• The ability of the monopoly firm to set price is
dependent on price elasticity of the product – if
demand is elastic it will limit the firms price setting
power
Price takers
• Firms in perfect competition are price takers
• All businesses have to accept the price that is set
by the market
• Firms are not able to set their own price
Factors that influence the ability of a firm to
be a price maker
• Only firms in pure monopolies can be price makers
• This means that there must be:
– Barriers to entry and exit
– Only one producer / firm in the market
– Imperfect knowledge
• In reality this is seldom the case and pure
monopolies rarely exist
Factors that influence the ability of a firm to
be a price maker
• Very few markets are dominated by just one firm – it is more likely
that they are dominated by a few major firms who are able to act as
price makers
• Barriers to entry do exist in many markets however they may be
overcome in a number of ways including:
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Takeovers from outside / inside the industry
Growing markets
Increased overseas competition
Transfers of brand names between sectors of the economy in companies that
differentiate their product offerings
Price Makers
• As pure monopolies rarely exist having one firm as
a price maker is unlikely
• If firms are able to set prices in a market the extent
to which they can is influenced by price elasticity for
that market, the more inelastic the demand for a
product the more a firm can set the price
The Growth Of Firms
• Growth is often a key objective of firms
• Business grow for a number of reasons including:
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To increase profits
To decrease costs
To dominate the market
To reduce risk
To fulfil objectives of management
Internal and External Growth
• Businesses can choose to grow internally by selling
more of their products or externally by acquiring /
merging with another firm
• Internal growth is often referred to as organic
growth
• Internal growth is slower
External growth - Takeovers
• Takeovers are where one firm gains control of
another firm
• The amount a firm pays to takeover another firm is
dependent on its perceived value
• Attacker firms often pay a premium to shareholders
in order to secure their shares
• Bids can be hostile or welcome
• Hostile bids have a greater degree of risk
Mergers
• Mergers occur when at least two firms join together
to form one organisation
• Mergers and takeovers can take the following
forms:
– Horizontal – firms join together who are at the same
stage in the production process
– Vertical – firms join together who are at different stages
in the production process
– Conglomerate – firms in different markets join together
Why do firms merge ?
• Mergers and takeovers are ways for businesses to
grow
• Firms decide to merge / take over due to synergy
• Synergy is where the performance of the new firm is
greater than the performance of the separate firms
• Synergy is created by shared resources, ideas and
skills
Management Buyouts
• Where managers in a business take it over by
buying a controlling interest in its shares
• Managers may do this as they think they can turn
the business around, or if shareholders lose interest
in a particular part of the business
• Manager often need to borrow money to finance
MBOs
• MBOs are risky however if successful they allow
managers to reap plenty of rewards
Joint Ventures
• Joint ventures occur when two businesses set up a third
business together to develop a new product, enter a new
market etc
• Joint ventures are set up to achieve a specific objective or
project for both parties
• There are benefits for both parties from these relationships
• Sony and Ericsson enjoyed a joint venture where they
worked together to develop mobile phones
Outsourcing
• Outsourcing allows a business to contract out some of their
operations to a third party to perform
• Outsourcing of production overseas has allowed
businesses to reduce their costs e.g. call centres locating
overseas in lower wage countries
• Outsourcing has been driven by technological change,
pressure on profit and costs and an increase in the level of
competition
Sources of Monopoly Power
• Monopoly power is influenced by the following
factors:
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Barriers to entry
Number of competitors
Advertising
Degree of product differentiation
Sources of Monopoly Power
• The larger and more expensive the barriers to entry the
greater the monopoly power
• The smaller the number of competitors in the market the
greater the monopoly power
• The greater the advertising spend and more recognisable
the brand name the greater the monopoly power
• The larger the degree of product differentiation the greater
the extent of the monopoly power :
The Model Of Monopoly
Monopoly Model
• In the monopoly model the average revenue curve
is the same as the demand curve
• Where total revenue exceeds total costs the firm is
able to make supernormal profits
Collusive Oligopoly
• Collusion occurs where the firms work together to
reduce uncertainty in the market
• Firms may become involved in price fixing or cartels
to act as though they are the only firm in the market
and therefore can set prices
• This is illegal in the UK and EU
Price fixing and collusion
• Price fixing is where all firms in the market try and control
supply to achieve a “monopoly” like situation
• For this to happen producers need to have an influence
over supply
• This is most likely when the market is dominated by a few
large firms, demand is inelastic, market demand doesn’t
fluctuate and you can easily quantify the output of each firm
Price leadership and collusion
• Where one firm is dominant in the oligopoly they
often take the role of price leader setting the price
for the market
• Tacit collusion – is where companies are engaging
in behaviours which minimise the response of
competitors
• In the UK the supermarket business could be seen
as behaving in a way similar to tacit collusion
Non Collusive Oligopoly
• Oligopolies are markets which have the following
features:
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A few large firms
Entry barriers
Non price competition
Product branding and differentiation
Interdependence in decision making
Oligopolies
• Firms operating in oligopolies tend to invest heavily in new
machinery and processes to try and reduce their cost
structure and make more profits
• Research and development expenditure is also high as
businesses try and differentiate their products from their
competitors
• Businesses in oligopolies use advertising and marketing to
build strong brand recognition which allows them to
compete on factors other than price and acts as a barrier
to entry for new firms
Non Price competition
• In oligopolies the majority of competition is non-price
• This aims to influence demand and build brand recognition
• Methods include:
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Better customer service
Discounts on upgrades
Free deliveries and installation
Extended warranties
Credit facilities
Longer opening hours
Product branding
After sales service
Price Wars
• Firms tend to compete on non price factors as
competing on price can lead to price wars
• Price wars occur when one competitor lowers its
price, then others will lower their prices to match . If
one of the firms reduces their price below the
original price cut, then a new round of reductions is
begins.
Entry Barriers
• Oligopolies have a number of barriers to entry
– Size of the firms in the market means they can influence
output and price
– Larger firms can exploit economies of scale
– Branding and brand recognition
Interdependence in Oligopolies – Kinked
Demand Curve
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Firms in an oligopoly face a kinked
demand curve
If they raise price above P* the
demand curve is relatively elastic as
people will switch to buying substitute
products from competitors
If they drop price below P* they face
an inelastic demand curve as other
firms will also cut prices so few gains
in quantity demanded occur
Interdependence in Oligopolies – Game
Theory
• Game theory looks at the players in a game or firms
in a market
• In making decisions each player has a number of
choices
• Each player is influenced by their own actions and
the actions of other players
• Game theory can be used to illustrate the
interdependence of firms in an oligopoly
Price Discrimination
• Price discrimination is where a firm charges different prices
for the same product to different consumers
• The most common example is peak and off peak pricing for
travel
• For price discrimination to work the following conditions are
needed:
– Differences in price elasticity of demand between markets
– Barriers to prevent consumers switching between suppliers
Price Discrimination
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Perfect Price Discrimination – this is where the firm
charges whatever the market will bear.
This means the producer can transfer all of the consumer
surplus to producer surplus.
This could hypothetically happen if a monopolist was able
to segment the market precisely however it is very
unlikely to occur in real life
Price Discrimination
2. Second degree price discrimination – where packages of
products that are surplus to requirements are sold at lower
prices
• This often happens with last minute holiday deals where
businesses are selling off their spare capacity to gain some
revenue
• In the low cost airline sector firms operate a strategy
opposite to this where the cheapest flights are those you
book the furthest in advance
Price Discrimination
3. Peak and Off Peak pricing – this is where a different
price is charged due to the time of day / year
• During peak times there is more demand for the
product so higher prices can be charged – demand
is likely to be more inelastic
• Examples of peak / off peak include rail travel,
holidays and phone calls
Price Discrimination
4. Third degree price discrimination – Charge different
prices for different products to different market
segments
• Markets are usually segmented by time or
geographical area
• E.g. having one price for the UK and one for the
USA
Advantages and Disadvantages of Price
Discrimination
Advantages
• Increases profit for the firm
• Increase in size of producer
surplus
• Firms may be able to exploit
economies of scale
• Can be used to cross subsidise
goods with high social benefits
Disadvantages
• Reduction in size of consumer
surplus
Consumer and Producer Surplus
• Consumer surplus – This is the difference between what a
person would be willing to pay and what they actually pay
to buy a product.
• It is the area below the demand curve and above the price
• Producer surplus – This is the difference between the price
where a producer would be willing to provide a product and
the actual price the product is sold
at
Consumer Surplus
• The consumer surplus is
shown by the shaded area
on the diagram
• At a price P1 all
consumers in the shaded
area would pay more for
the good and therefore
they gain extra benefits
from the lower price
Producer / Consumer Surplus and
Efficiency
• If the market is perfectly competitive at equilibrium
price and quantity consumer and producer surplus
will be maximised
• This represents the most efficient output level
Price Discrimination and Producer /
Consumer Surplus
• If first degree price discrimination occurs then the
consumer surplus is removed and transferred to
producer surplus
• Other forms of price discrimination also reduce the
consumer surplus and increase the producer
surplus
Consumer Surplus and Monopoly
• In Monopolies the consumer surplus is reduced
• Some of this reduction is passed to producers in the
form of the producer surplus
Contestable and Non Contestable Markets
• Contestability markets are where there is one firm (or a
small number of firms) and due to freedom of entry and
exit, the firm (or firms) face competition from potential new
entrants and so operates like a perfectly competitive market
• In reality there are barriers to contestability to most markets
• The majority of markets are contestable to some extent
• The degree of contestability is dependent on barriers to
entry
Conditions for Contestability
• The following conditions need to apply for pure market
contestability:
– Freedom of entry and advertisement
– Absence of sunk costs – these are costs that a business has to
pay to enter the industry that cant be recovered or recouped
– Perfect information
• Contestability means that businesses in a market will make
pricing and output decisions based on the threat of
competition
• Markets are become increasingly contestable due to
globalisation
Efficiency, Dynamic
Efficiency and Resource
Allocation
• Productive efficiency – is the level of production that
makes the most cost effective use of the factors of
production
• Allocative efficiency – is the level of production
where no resources are wasted, no one can be
better off without anyone else being worse off
• Perfectly competitive markets exhibit productive and
allocative efficiency
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Market Structure, Static
Efficiency, Dynamic
Efficiency and Resource
Allocation
• Efficiency is influenced
by a number of factors
including:
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research and development
investment in human and non-human capital
Technological change.
Candidates should be able to compare and discuss the
• The more competitive a market is the greater the
allocative efficiency of resources
Summary
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Monopolies operate where there is one firm in the market, they are able to set prices and have high
barriers to entry
Oligopolies have a few firms in the market, high brand recognition and heavy competition on non price
factors
Price makers are able to set the price for the market whereas price takers have to accept the market
price
Growth of firms – firms grow internally and externally through organic growth or mergers, takeovers, joint
ventures and management buyouts
Outsourcing is increasingly being used by firms to grow their operations
Monopolies have power as they are able to influence the price for the whole market
The model of the monopoly shows how the monopolist takes the industry demand curve as their own
Collusive and non collusive oligopoly – collusive oligopolies work together to set prices, non collusive
oligopolies do not
Interdependence in oligopolistic markets – companies take decisions based on the expected decisions of
others, all decisions are influenced by those of others and influence them
Price discrimination is where you charge a different price for the same product to different consumers
Consumer and producer surplus show the extra benefits to producers and consumers of a certain price
Contestability looks at the threat of entry of new firms to the market
Market Structure influences the allocation of resources within an economy