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More on Oligopoly
Firm s are interdependent and there is a high degree ofuncertainty in the m arket as a
change in one firm ’s m arketing m ix m ay bring about an unknow n change in another firm s
m arketing m ix.

Collusive Oligopoly

W here firm s act together as a single firm to gain m onopoly pow er.

Form al/open agreem ent

W here firm s act together and form a cartel.There is lots ofnon-price com petition w ithin a
cartel.Each firm has an allocated output (by m arket share pre-collusion).

Inform al/tacit agreem ent

Price leadership theories:

Dominant firm price leadership

W here the dom inant firm sets the price for the w hole industry.

Prices and
costs
M C LEAD ER

PL

AR LEAD ER = D LEAD ER

AR LEAD ER = D LEAD ER
M R LEAD ER
O QL QT Q/t

The leader sets a price,PL based on their ow n M C and M R curves,but taking into account
the other firm s cost curves.The price needs to be high enough to stop other firm s m aking
losses,w hich w ould attract the com petition com m ission to investigate the m arket.

Barometric price leadership

Barom etric firm sets the price.The barom etric firm is not the largest firm in the m arket but
has better know ledge and ability to forecast the future ofthe m arket.

N on-collusive Oligopoly;K inked dem and curve theory

This m odelassum es
• N on-price com petition
• Tw o dem and curves;and elastic and an inelastic.

The m odelaim s to explain price stability by the use ofthese tw o dem and curves.
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If a firm increases their price

Prices and
costs
Represents the loss in TR
P1
Pe Represents the gain in TR

AR = D

O Q1 Qe Q/t

Ifthe firm raises the price from Pe to P1 they w illm ake a net loss in TR so not pursue this
pricing policy,assum ing the firm is aim ing to m axim ise totalrevenue,as the pale blue area
is larger than the grey area.

If a firm decreases their price

Prices and
costs
Represents the loss in TR

Pe Represents the gain in TR

P2

AR = D

O Qe Q2 Q/t

So the price rem ains constant and stable.This leads to lots ofnon-price com petition w ithin
the m arket.

The tw o parts ofthe kinked dem and curve have different m arginalrevenue curves
associated w ith them ,so w e can draw the follow ing diagram .
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Prices and
costs

Pe

B
AR E = D E
O M RE
Qe M R I AR I = D I Q/t

W hich leads to the kinked dem and curve and m arginalrevenue curve w ith a discontinuity
AB,at the equilibrium output.

Prices and
costs

Pe

B
O Qe Q/t
MR AR = D
Ifthe M C curve fluctuates w ithin the discontinuity AB (betw een M C and M C’)there is no
m otivation for the first to change its equilibrium output,assum ing the firm is a profit
m axim ising oligopolists.

Prices and
costs
M C’
MC
Pe

B
O Qe Q/t
M RI AR I = D I
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Oligopolies have advantages and disadvantages.The firm can act against the consum er by
reducing consum er surplus,producing a low er quality product,reduce consum ers choice
and behave in a collusive m anner to exploit the consum er as a m onopolist.

There is lots ofnon-price com petition so consum ers can benefit from better quality
products and through technicaleconom ies ofscale large supernorm alprofits can be m ade
w hich can be invested into research and developm ent,so the oligopolists can be
advantageous to the consum er.

A capital-intensive oligopolist can have an im pact on unem ploym ent w ithin an econom y.
The labour required by oligopolists is highly specialised w hich m ay affect production costs.
For exam ple chem icaland car industries require lots ofcapitalfor production and highly
skilled w orkers to repair m achinery and to participate in research and developm ent.

Price W ars

In the short term consum ers benefit as they receive a product at a very low price and the
consum er feels they are getting a bargain.

Through m erger or takeover a m onopoly w illdevelop in the long run w hich is

disadvantageous to the consum er.

H it and run policy

W here a firm enters the m arket for a short period oftim e m akes supernorm alprofits then
leaves the industry.This can happen in contestable m arkets.

Contestable m arket

Contestability is the com petitiveness in the m arket betw een firm s.The follow ing are
characteristics ofcontestable m arkets.

• Firm s are able to diversify (invest in another m arket area com pletely outside of
their m arket).This allow s firm s in a contestable m arket to
o Reduce or elim inate losses;
o Reduce the risks ofproduction in any one m arket;
o Increase the chance and size ofsupernorm alprofits.
• Low /no barriers to entry.
• ‘Costless’exit from the m arket and entry to the m arket (there are no non-
recoverable or sunk costs such as advertising in a contestable m arket).This
encourages hit and run behaviour from som e firm s.
• The threat ofhit and run,w hen a firm enters the m arket for a short period oftim e,
m akes supernorm alprofits,then leaves.The fear ofattack from a hit and run firm
brings about efficiency in the m arket as firm s aim to suppress the large
supernorm alprofits that attract hit and run firm s to enter the m arket.This threat
m akes the m arket act like perfect com petition.

M arkets can be said to be contestable to a degree as in reality no perfectly contestable

m arket exists,as it is never possible to fully recover costs on leaving an industry,though
som e industries have very low entry and exist costs as developm ents in technology
im prove capitalm obility.

Com petition policy

The com petition com m ission is a group that encourages contestability through
deregulation and tougher com petition law s acting against predatory behaviour.
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The airline m arket

• In the late 1990s the European airline m arket w as liberalised,low ering the barriers
to entry.
• Traditionalfirm s then faced com petition as firm s could enter the m arket m ore
easily.
• N ew entrants used leased aircraft to keep costs low .
• Firm s have m erged (such as easyJet and Go in M ay 2002)to im prove the firm ’s
horizontalintegration.

These notes are from lessons on 13/10/2004 and 19/10/2004.