Oligopoly

Question 1

Characteristics of Oligopoly

Answer 1

• High barriers to entry and exit
• Few sellers in the market
• Non-price competion between firms
• Interdependence between firms in the market
• Price rigidity - price does not change easily
• Collusive - where firms deliberately follow the same pricing structure
• Cartels - groups of firms working together

Question 2

Examples of Oligopoly

Answer 2

• OPEC - Organisation of Petroleum Exporting Countries
• Supermarkets
• Car manufacturers
• Malt Beverage Industry
• Coke/Pepsi/Cadbury Schweppes
• Adidas/Nike/Reebok/New Balance/Puma/Converse
• Unilever/Procter & Gamble

Question 3

Non Collusive Oligopolies

Answer 3

Highly interdependent but not colluding

Question 4

Price leadership

Answer 4

• When one firm would dominate the market and other firms would follow the leader firm
• Tacit collusion

Question 5

Cartels

Answer 5

• Formal collusion between firms
• Setting output and price
• Often illegal
• Anti-trust laws (government solution)

Question 6

How would you show welfare loss in a monopoly or an oligopoly as a monopolist?

Answer 6

Question 7

Game Theory

Answer 7

• Model to predict oligopolistic firms’ reactions in various scenarios
• Explains why collusive oligopoly likely breaks down due to firms’ self-interest.

Question 8

Concentration Ratio

Answer 8

Shows the output gap between leading firms and the entire industry.

• CRx = % (x is the # of largest firms)

Example - CR4 = 90%

• The US malt beverage industry has 160 firms, but 4 dominate 90% of output (high concentration).
• In contrast, the frozen fish industry has 600 firms with a CR4 of 19 (low concentration).

Question 9

Types of Non Price Competition

Answer 9

• Brand names
• Packaging
• Special features
• Advertising
• Sales promotion
• Personal selling
• Publicity
• Sponsorship deals
• Special distribution (e.g. free delivery, after sales service)

Question 10

What tools do non-collusive firms have against their competitors if they have price-stickiness/price rigidity?

Answer 10

Non-price competition

Question 11

Advantages of Oligopoly

Answer 11

• Can be efficient and take advantage of EOS
• Able to divert abnormal profit to R&D, hence innovation
• Avoid wasteful duplication involving large capital outlays

Question 12

Disadvantages of Oligopoly and why are oligopolies a form of market failure?

Answer 12

• No competition → less efficient
• Risks in terms of output
• No freedom of choice
• Higher prices
• Restricted production
• Not allocatively or technically efficient
• No incentive to research new product or innovate

Question 13

What are the advantages of large firms having significant market power? (from the syllabus) (important!!)

Answer 13

• EOS including natural monopolies
• Abnormal profits may finance investments in research and development (R&D), hence innovation

Question 14

What are the risks in markets dominated by one or a few very large firms? (from the syllabus)

Answer 14

Risk:

• Output
• Price
• Consumer choice

Question 15

What can the government do about the problems?

Answer 15

• (Anti-trust) Legislation and regulation
• Government ownership (rare) - “nationalisation”
• Fines
• Regulatory bodies

Question 16

Anti-trust Legislation and Regulation

Answer 16

• Prevent mergers or takeovers
• Laws against price fixing
• Prevent price manipulation and selective selling.
• Promote competition by reducing barriers.

Question 17

Regulatory bodies

Answer 17

• Ability to set price controls (price capping)
• Ability to impose fines
• Insist on average price levels (‘fair rates of return”)
• Make firms ‘unbundle’ their products
• Break up monopolies or sell assets.
• Set quality standards.