Oligopoly
By Chris and Harrison (Ford?)
What is an Oligopoly?
Oligopolies may be identified using concentration
ratios, which measure the proportion of total market
share controlled by a given number of firms. When
there is a high concentration ratio in an industry,
economists tend to identify the industry as an
oligopoly.
In normal people words: When a small number of
companies own a large section of the industry.
Key Characteristics
• Interdependence
Firms working in such close proximity to each other have to
take action against their competitors actions and their
potential actions
• Strategy
Because firms cannot act independently, they must
anticipate the likely response of a rival to any given change
in their price, or their non-price activity. In other words, they
need to plan, and work out a range of possible options
based on how they think rivals might react.
Key Characteristics Cont.
• Barriers to entry
• Natural
Economies of scale
Ownership/Control of a scarce resource
High set-up costs
High R&D costs
• Artificial
Limit/Predatory pricing
Advertising in an Oligopoly
Oligopolistic firms can gain maximum from advertisement
by increasing its market share as well as increasing total
market demand. To achieve this, they need to establish the
superiority of their products over those of their competitors,
and in doing so they must also counter the impact of
advertisement of the competitors.
Advertising may or may not result in improved consumer
benefits and efficiency. When advertising results in
increased sales and in turn increased production, it may
lead to economy of scale. But advertising itself involves
some cost. Advertising improves efficiency only when
savings from economy of scale exceeds the cost of
advertising.
Advertisements
• Pros
Product placements from companies to advertise their
products help fund the projects they are promoted in, like
movies or scholarships
• Cons
Advertising is a sunk cost - the more that is spent by
incumbent firms the greater the deterrent to new entrants.
Collusion
• Overt
Overt collusion occurs when there is no attempt to hide
agreements, such as the when firms form trade associations like
the Association of Petrol Retailers.
• Covert
Covert collusion occurs when firms try to hide the results of their
collusion, usually to avoid detection by regulators, such as when
fixing prices.
• Tacit
Tacit collusion arises when firms act together, called acting in
concert, but where there is no formal or even informal
agreement. For example, it may be accepted that a particular
firm is the price leader in an industry, and other firms simply
follow the lead of this firm.
Pricing Strategies
•
Oligopolists may use predatory pricing to force rivals out
of the market. This means keeping price artificially low,
and often below the full cost of production.
• They may also operate a limit-pricing strategy to deter
entrants, which is also called entry forestalling price.
• Oligopolists may collude with rivals and raise price
together, but this may attract new entrants.
Pricing Strategies cont.
• Cost-plus pricing is a straightforward pricing method,
where a firm sets a price by calculating average
production costs and then adding a fixed mark-up to
achieve a desired profit level. Cost-plus pricing is also
called rule of thumb pricing.
• There are different versions of cost-pus pricing,
including full cost pricing, where all costs - that is, fixed
and variable costs - are calculated, plus a mark up for
profits, and contribution pricing, where only variable costs
are calculated with precision and the mark-up is a
contribution to both fixed costs and profits.
•
Pricing Strategies cont.
Kinked demand curve
The reaction of rivals to a price change depends on
whether price is raised or lowered. The elasticity of
demand, and hence the gradient of the demand curve, will
be also be different. The demand curve will be kinked, at
the current price.
Even when there is a large rise in marginal cost,
price tends to stick close to its original, given the
high price elasticity of demand for any price rise.
At price P, and output Q, revenue will be maximized.