Economics of Oligopoly
Topic 3.3.9
Economics of Oligopoly
Topic 3.3.9
Students should be able to:
•
•
•
•
Understand the characteristics of this market structure with
particular reference to the interdependence of firms
Explain the behaviour of firms in this market structure
Explain reasons for collusive and non-collusive behaviour
Evaluate the reasons why firms may wish to pursue both
overt and tacit collusion
Key Concepts – Oligopoly
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 face a dual
demand curve for its product based on
the likely reactions of other firms
Price leadership
Prisoners’ dilemma
When one firm has a dominant position
and firms with lower market shares
follow the price changes of the leader
Problem in game theory that
demonstrates why two people might not
cooperate even if in their best interests
Basics of an Oligopoly
• An oligopoly is an imperfectly competitive
industry where there is a high level of market
concentration.
• Oligopoly is best defined by the actual conduct
(or behaviour) of firms within a market
• The concentration ratio measures the extent to
which a market or industry is dominated by a
few leading firms.
• A rule of thumb is that an oligopoly exists when
the top five firms in the market account for
more than 60% of total market sales.
Oligopoly in Action! UK Petrol Market
0.0%
2.0%
4.0%
Market share, per cent
6.0%
8.0%
10.0% 12.0%
14.0%
16.0%
Tesco
16.5%
BP
14.4%
Shell
13.2%
Esso
10.9%
Sainsbury's
10.3%
Morrisons
10%
Asda
6.8%
Texaco
5.8%
Certas Energy
3.8%
Murco
2.3%
Jet
2.2%
Unbranded
1.5%
Minor brands
0.8%
Harvest Energy
0.7%
Maxol
18.0%
0.4%
Oligopoly in Action! UK Cinema Market
0.0%
Cinema market share in 2013 (per cent)
5.0%
10.0%
15.0%
20.0%
25.0%
Cineworld
25.5%
Exhibitor
Odeon
23.9%
Vue
National Amusements
Empire Cinemas
Others
22.2%
5.8%
3.8%
18.7%
30.0%
Shares of the Global Car Industry in 2013
Global market share of the world's largest automakers in 2013
0.0%
Toyota
General Motors
Volkswagen
Hyundai-Kia
Renault-Nissan
Ford
SAIC Motor
Fiat-Chrysler
Honda
Suzuki
Peugeot
Daimler
BMW
Chang
Other
2.0%
Market share
6.0%
8.0%
4.0%
10.0%
12.0%
14.0%
12.3%
12%
11.9%
9.3%
8.4%
7.8%
6.3%
5.3%
SAIC Motor Corporation
Limited is a Chinese stateowned automotive
manufacturing company
headquartered in Shanghai,
China
4.4%
3.2%
3.4%
2.8%
2.4%
2.4%
8%
A Contestable Oligopoly
Market share of mobile handset manufacturers in the UK in June 2014
35.0%
31.8%
30.0%
Market share
25.0%
22.9%
20.0%
16.9%
15.0%
10.0%
6.7%
7.4%
6.1%
5.0%
3.7%
2.4%
2.1%
Motorola
LG
0.0%
Samsung
Apple
Nokia
Sony
HTC
RIM
Other
Revenue of dominant sports betting companies
0
0.5
Revenue in billion U.S. dollars in 2014
1
1.5
2
2.5
William Hill
2.5
bet365
2.18
Ladbrokes
1.82
Paddy Power
1.07
bwin
0.74
betfair
0.73
Unibet
0.48
3
Characteristics of an Oligopoly
Best defined by the actual behaviour of firms
A market dominated by a few large firms
High market concentration ratio
Each firm supplies branded products
Barriers to entry and exit
Interdependent strategic decisions by firms
Meaning of Strategic Interdependence
• Strategic interdependence means that one firm’s
output and price decisions are influenced by the
likely behaviour of competitors
• Because there are few sellers, each firm is likely to
be aware of the actions of the others.
• Decisions of one firm influence, and are influenced
by, the decisions of other firms
• This causes oligopolistic industries to be at high risk
of tacit or explicit collusion which can lead to
allegations of anti-competitive behaviour
• In oligopoly there is a high level of uncertainty
The Kinked Demand Curve
• A business in an oligopoly faces a downward
sloping demand curve but the price elasticity of
demand may depend on the likely reaction of rivals
to changes in one firm’s price and output
• (a) Rivals are assumed not to follow a price
increase by one firm, so the acting firm will lose
market share - therefore demand will be relatively
elastic and a rise in price will lead to less revenue
• (b) Rivals are assumed to be likely to match a price
fall by one firm to avoid a loss of market share. If
this happens demand will be more inelastic and a
fall in price will also lead to a fall in total revenue
The Kinked Demand Curve - Analysis
Price
and
Cost
•
•
Theory starts with assumption that
firms are settled on a price P1 and
quantity Q1
At price D1 the demand curve is
elastic above P1 and it is demand
inelastic below P1
P1
AR1
AR2
Q1
Output
Kinked Demand Curve – Raising Price
Price
and
Cost
•
•
•
P2
Raising price above P1: Likely reaction
of other firms is to hold their prices
This will cause an elastic demand
response for this firm
Results in lost sales and falling total
revenue
P1
AR1
AR2
Q2
Q1
Output
Kinked Demand Curve – Cutting Price
Price
and
Cost
•
P2
Cutting price below P1 – the likely
reaction of other firms is to follow the
price reduction. Demand likely to be
relatively inelastic – little benefit in
terms of extra sales and total revenue
P1
AR1
P3
AR2
Q2
Q1
Q1
Output
Kinked Demand Curve – The Kink!
Price
and
Cost
•
If demand is relatively elastic following
a price rise and relatively inelastic after
a price fall – we create a kink in the
oligopolists demand curve (AR)
P2
P1
AR1
P3
AR2
Q2
Q1
Q1
Output
Kinked Demand Curve – The MR Curve
Price
and
Cost
•
•
•
The marginal revenue curve is always
twice as steep as average revenue
There will be two marginal revenues
curves if AR is kinked
We find a vertical intersection – at
quantity Q1 the two curves do not
actually intersect
AR1
Output
MR1
Kinked Demand Curve – Equilibrium?
Price
and
Cost
•
Is there a profit maximising equilibrium
in this market? In the diagram here
MC1 cuts through the gap in the
marginal revenue curve
MC1
AR1
Kinked demand curve model assumes:
Other firms will follow if prices are cut
Firms will not follow if prices rise
Output
MR1
Kinked Demand Curve – Price Rigidity
Price
and
Cost
•
One of the key predictions of the
kinked demand curve model is that
prices will be rigid or “sticky” even
when there is a change in the marginal
costs of supply (this is assuming that
firms in the market are profit seeking)
AR1
Output
MR1
Kinked Demand Curve – Price Rigidity
Price
and
Cost
•
One of the key predictions of the
model is that prices will be “sticky”
even when there is a change in the
marginal costs of supply (assuming
that firms are profit seeking)
MC2
MC1
AR1
Kinked demand curve model assumes:
Other firms will follow if prices are cut
Firms will not follow if prices rise
Output
MR1
Kinked Demand Curve – Overview
On oligopoly firms have price-setting
power but may be reluctant to use it
Rivals unlikely to match a price rise and
rivals likely to match a price fall
If a firm is settled on one price, there
may e 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
Examples of Non-Price Competition
Innovation
Quality of service
including after-sales
Free Upgrades to
Products
Exclusivity / Loyalty
Schemes
Branding
Sales Promotions
UK advertisers ranked by spending
0
50
Expenditure in million £ in 2013
100
150
200
British Sky Broadcasting Ltd
177.26
Bt Ltd
149.79
Unilever UK Ltd
119.1
Tesco Plc
116.27
Asda Stores Ltd
97.04
Talktalk Grp
William Morrison Supermarkets Plc
300
264.34
Procter & Gamble Ltd
Virgin Media
250
92.55
88.36
81.52
Dfs Furniture Co Ltd
75.68
Vodafone Ltd
74.59
McDonalds Restrs Ltd
72.15
Reckitt Benckiser (UK) Ltd
68.98
Loreal Paris
63.59
Nestle
63.15
Real World Examples of Price Wars
Low cost
airlines
Supermarket
petrol
Mobile phone
tariffs
Price wars and impact on suppliers
Supermarket price war squeezes small supplier profit margins by a third
A report published in November 2015 found that small suppliers with an annual
turnover below £25m lack the negotiating power of big rivals and as a result,
their profit margins have fallen in one year from 3.5% to 2.1%. By contrast, at
the biggest food companies, whose turnover tops £1bn, margins increased from
5.2% to 5.4% last year
Who Wins and Loses from Price Wars?
Price wars may lead to short run increases in
sales and revenues, but may not be in the
long-term commercial interests of a business
Winners
Losers
• Regular
consumers
• Managers –
higher sales
• Shareholders lower profits
• Suppliers – may
get squeezed
Long Term Tendency towards Oligopoly
Economies of scale
• Large minimum efficient scale (high ratio of fixed to
variable costs of production)
Mergers and takeovers
• Consolidation of industries through acquisitions e.g.
horizontal integration between suppliers
Rise of dominant brands
• High rates of profits and barriers to entry & exit
Economics of Oligopoly
Topic 3.3.9