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Oligopoly

Oligopoly

A market where a few large sellers dominate the market for an identical or differentiated good, and where there are significant barriers to entry.

Assumption

  • The dominance of the industry by a small number of firms.
  • The importance of interdependence
  • Differentiated of homogenous product
  • Higher barriers to entry

Duopoly

Where the market is shared between two big players, can be seen as an extreme form of oligopoly.

Collusion oligopoly

Exists when oligopolistic firms formally or tacitly agree to fix price or to engage in other anti-competitive practices.

  • The smaller the number of firms, the better for the collusion.

  • If the firms in an oligopoly collude, the profit of the industry is maximized.

  • Individual firms in collusion oligopoly are price takers, so their demand curve is flat.

Formal collusion

Takes place when firms openly agree on the price, market share, or output.

Cartel

Is a group of competitors that successfully limit competition and keep prices above a competitive norm.

Tacit / informal collusion

Occurs when a single dominant firm establishes price leadership. The leading firm sets general price level, and smaller firms follow with comparable prices.

Advantages:

  • Price is stable

Disadvantages:

  • Usually illegal; charging higher price and restricting output
  • Cartel structures are unstable due to cheating

Cartel structures are unstable

  • Cost difference between firms
  • Product differentiation
  • Market share the smaller, the greater incentive to leave as membership benefits might not be significant
  • Priority to survive during recession
  • Supernormal profits will attract new firms into industry [short-run barrier, but might change in long-run]
  • Lack of a dominant

Non-collusive oligopoly

When oligopolistic firms compete through price or non-price competition.

Non-collusive oligopoly price war

  • An oligopolist would only start a price war if its cost of production were significantly lower than its rivals.
  • A price war might be the natural outcome of economic events, such as overcapacity in the industry or the entry of new firms.
  • The observation that price tends to be similar between oligopolists and are stable with time might be explained by the kinded demand curve theory

The game theory

A model of strategic behavior that exists in an oligopolistic market. The model explains how business react to each other decisions in interdependent decision-making situations. The strategic element explains how firms plan their pricing decisions in response to their competitors.

Evaluation of oligopoly

Advantages for consumer：

  • Product differentiation
  • New technology & continual product improvement
  • Price stability
  • There is price war between competing firms

Advantages for producer:

  • Economic profit in long-run
  • Economic profit encourages development of new technologies
  • Economies of scale
  • Cartels can enjoy producer sovereignty

Disadvantages for consumer:

  • Consumer have to pay for firms’ expense on non-price competition
  • Collusive oligopoly restricts output & keep Ps high
  • Allocative & productive inefficiency

Disadvantages for producer:

  • Intense competition in a non-collusive oligopoly
  • Cartels run the risk of penalty by governments

Price discrimination

The practice of charging a different price for the same product to different consumers when the price difference is not justified by differences in costs of production. (If price differences are due to differences in a firm’s cost of production, then they do not qualify as ‘price discrimination’.)

Conditions:

  • The price-discriminating firms must have some market power
  • Separation of consumers into groups to avoid the possibility of resale
  • Different price elasticity of demand

Degree

  • First-degree price discrimination: takes place when each consumer pays exactly the price that they are prepared to pay. In this way, the producer is able to turn the entire consumer surplus into their revenue.
  • Second-degree price discrimination: takes place when the producer charges different prices to consumers depending on how much they buy.
  • Third-degree price discrimination: takes place when consumers are identified in different market segments with different PEDs, and a separate price is charged in each market segment.

Effects

Advantages:

  • Enables producer to gain a higher revenue from a given amount of sales
  • Enables producer to produce more of the product & thus gain from economies of scale
  • Enables a firm to drive competitors out of the more elastic market
  • “subsidizing” poor consumers

Disadvantages:

  • Some, if not all, of consumer surplus that existed before price discrimination will be lost
  • Some consumers will pay more than the price that would have been charged in single, non-discriminated market.

Overall, society may benefit from PD as firms extend output to lower-income groups & welfare loss is reduced. Greater allocative efficiency is sometimes achieved as well. Also, greater output levels may inspire firms to reduce costs & achieve economies of scale.

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