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Saturday, 21 April 2012

Oligopoly

·       A type of market structure where there are a small number of firms dominating the market, all selling similar goods

·       What’s your definition of ‘dominating’ the market? How do economists go about determining whether a market is dominated by a few firms or not? They measure the concentration ratio – the market share of the biggest firms in the market. For example, a four firm concentration ratio shows the percentage of output produced in the market by the four largest firms. Statistically, this method is okay to use, but at A-level (and GCSE), it is better that you know that the essence of understanding the oligopoly market is that firms in the market make decisions on price and output based on the decisions of rival firms. They attempt to predict what the other firms are doing, to compile their own strategy.

·       An example of an oligopoly market is supermarkets

·       Can compete on price (resulting in a price war, see here and here) or not, instead competing on other bases such as:
o   Loyalty schemes (Tesco Clubcard, Sainsbury’s Nectar points)
o   Advertising and marketing
o   Home delivery options (e.g. Asda and Tesco)
o   Discounted petrol  (e.g. Asda, Morrisons)
o   Extension of opening hours (e.g. Metro Bank open on Sundays)
o   Lateral growth in other industries (Asda opticians, Tesco banking and insurance)

·       There are barriers to entry in the market

Kinked Demand Curve Theory

The theory explains how a competitive oligopolist may be affected by rivals’ reactions to its price and output decisions.



 Look at the AR curve for now. The AR curve is relatively elastic from P* to P1 and relatively inelastic P1 onwards.
The oligopolist sets price to P1 initially. When the curve is relatively elastic, if a firm in the market increases the price, other firms will not follow because the resulting fall in demand is greater than the proportionate change in price. The firm loses too much demand to attract other firms to follow.
When the curve is relatively inelastic, if a firm lowers the price, other firms will follow because they benefit from the resulting increase in demand. Even though the resulting increase in demand is lower than the fall in price, firms benefit because consumers ‘shop around’ for lower prices; if Tesco are selling a notebook for £1 and Asda are selling a notebook for 80p, provided that Asda is just as accessible as Tesco, the consumer may decide to shop at Asda instead. This is under the assumption that the oligopoly market compete on price. If this happens, a price war may result.

Now consider the MR and MC curves. The oligopolist sets price and output level to P1 and Q1. The profit maximising level of output is Q1. The initial MC curve is MC2, but if the MC curve was to shift to above MC1 or below MC3, the oligopolist would have to charge a different price to ensure profit maximisation (assuming AR = selling price). Price stability is achieved because the MC curve can be anywhere between MC1 and MC3.
Furthermore contributing to price stability, the oligopolist may decide to leave price and output at point X because of the uncertainty from rivals’ price and output decisions.

The Kinked Demand Curve is only a theory and an estimate of how demand changes when the oligopolist changes price because there is not perfect information in the market for olipogolists to know the exact position and shapes of their demand and revenue curves. The theory is useful because it illustrates how firms are interdependent on rivals, and affected by uncertainty.

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