Oligopoly

Oligopoly: A market structure in which a small number of firms producing the same good or close substitutes and take into account each other’s reaction. 

Irish Example:

  • Banking industry (AIB. BOI, Ulster…)
  • Supermarket industry (Tesco, Aldi, Supervalu, Lidl…)

Assumptions of Oligopoly 

  • Few firms dominate the industry: Because of this each seller can influence the rice of the commodity and/or output sold.
  • Interdependence between firms: Firms in oligopoly do not act independently of each other. They will each take into account the likely actions of their competitors; hence prices tend to rigid.
  • Product differentiation occurs: The commodities which firms sell are close substitutes. Firms will engage in advertising to persuade consumers to buy their product rather than a competitor’s product.
  • There are strong barriers to entry: These are common in an oligopolistic market, as existing firms will wish to maintain their share of the market. Eg. Patents, high cost to entry.
  • Collusion may occur: Firms in industry may try to control price or output.
  • Non-Price Competition is more common than price competition; Oligopolies tend to compete on terms other than price. Eg. Advertising
  • There are strong barriers to entry.
  • Firms recognize their mutual interdependence and engage in strategic behaviour.
  • Oligopolies can earn abnormal profits in long run
  • Non-Price Competition; Oligopolies tend to compete on terms other than price.

Introduction to game theory

Is a method of analysing the way that the ‘players’ in an interdependent relationship (such as oligopoly) make strategic decisions.

Oligopoly explained by mjmfoodie

Calculating the concentration ratio

A step by step guide to calculating concentration ratios of firms in a market.

Introduction to game theory

Is a method of analysing the way that the ‘players’ in an interdependent relationship (such as oligopoly) make strategic decisions.

Prisoners dilemma explained by investopedia

Prisoners dilemma explained by ‘The Place’

You and a friend have committed a crime and have been caught. You are being held in separate cells so that you cannot communicate with each other. You are both offered a deal by the police and you have to decide what to do independently. Essentially the deal is this:

Nash Equilibrium

A concept of game theory where the optimal outcome of a game is one where no player has an incentive to deviate from his or her chosen strategy after considering an opponent’s choice. Overall, an individual can receive no incremental benefit from changing actions, assuming other players remain constant in their strategies. A game may have multiple Nash equilibria or none at all.

A Beautiful Mind – The Documentary John Nash

A clip from the movie about John Nash, the founder of game theory.

EconMovies: The Dark Knight (Oligopolies and Game Theory)

Collusion: Rival sellers in the industry come together for their mutual benefit.

  1. Explicit collusion occurs when separate companies jointly decide a specific course of
    action by forming a cartel e.g. OPEC (Organisation Of Petroleum Exporting Countries).

This collusion might include:
a) A fixed price which applies to all firms in the cartel
b) A quota system which limits production to certain agreed amounts, keeping prices higher than they should be.

  1. Implicit collusion occurs when there is no formal agreement between firms but each
    firm recognizes that joint profits will be higher if firms behave as if they were a monopoly.
    A single firm will not reduce the prices of its output because it knows that such a move could result in a price war with smaller profits for all firms involved in the industry, firms therefore will compete by means of non-price competition.

Types of collusion 

  1. Pricing Policy / Limit Pricing
    One firm, with the tacit agreement of others, could reduce prices forcing unwanted entrants out of the industry.
  2. Production/output policy
    Firms could join together to limit output to certain agreed amounts.
    3. Sales Territories.
    Firms could divide up the markets between them and agree not to compete in each other’s
    market segments.
    4. Refusal to supply firms.
    Firms may not supply those firms who buy from firms not in the cartel.
    5. Implicit Collusion
    Each firm recognises that behaving as if they were branches of a single firm their joint profits would be higher. So firms do not provoke their rivals by cutting prices. Instead they try to increase market share by engaging in non-price competitive measures.

Collusion by Mjmfoodie

Reasons why Consumers may prefer Price Competition

  • Lower prices / value for money: Consumers will benefit from availability of commodities at lower prices. Consumers will be able to get better value for their limited income.
  • Higher disposable income: With lower prices consumers will now have a higher disposable income, resulting in a better standard of living.
  • More choice: As consumers have a greater disposable income they can now choose how to spend this additional income.
  • Preferable to non-price competition: Consumers pay for non-price competitive measures e.g. advertising; Offers may be unwanted / of little value; tokens may go unused etc.

Reasons why Consumers may prefer Non-Price Competition

  • Consumer loyalty is rewarded: Consumers can, by shopping in selected stores, receive loyalty points which can be used as they wish.
  • Stability in prices: Non-price competition means prices will not be constantly changing and so consumers do not have to worry that they are losing out on bargains / may be better able to budget.
  • Better quality commodities / services: Firms may improve the quality of their commodities; offer better service and/ or after sales service to consumers.
  • Allows consumers to save and / or avail of ‘free’ gifts: With regular shopping consumers can ‘save’ their loyalty points for those time periods when they incur additional expenses.

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