Oligopoly

=[|As an introduction to this fascinating topic please read this article before next lesson and come prepared to discuss]=

OLIGOPOLY

An oligopoly is defined as a market dominated by a few producers: each of which has some control over the market. Examples of oligopolies include:


 * · Petrol retailing ||
 * · Washing powder market ||
 * · banks ||
 * · Mobile Telecommunications ||


The concentration ratio is one measure of the extent to which a market or industry is dominated by a few leading firms. Normally an oligopoly exists when the top five firms in the market account more than 60% of total market demand/sales for. In the example below we look at the market share of mobile phone manufacturers



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the 7 largest firms have approximately 80% Market share. This would be classified as an Oligopoly.

Another example maybe retail banking in China (do some research on this for homework)Equally ISPs are a rapidly changing market. Microsoft IE used to have a near monopoly but now the market is becoming more competitive. Use this excellent resource to undertake some research on this.[|http://timetric.com/dataset/netmarketshare/]

Worked Example:



Measure the 5 firm CR for these two industries. What does this tell us? 

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">There is no single theory of how firms determine price and output under conditions of oligopoly, but the industry is likely to exhibit the following features:

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· A few firms selling similar products <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Each producing branded products (this is in effect non-price competition) <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Significant barriers to entry. <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Firms have to take into account likely reactions of rivals to any change in price(interdependence). This interdependence creates a lot of uncertainty as firms also have to take into account the behaviour of other firms. "Game Theory" tries to help us understand how firms will behave.

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">GAME THEORY-THE PRISONERS DILEMMA

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<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">So the diagram above could help us explain why firms may want to collude (they do better if they agree to maintain prices) However it also does not mean that collusion is inevitable. Price wars may break out because firms have the incentive to be selfish and try and get a better situation at the expense of the other firm (or person). Let's have a look at the prisoners' <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; line-height: 24px;">dilemma <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px; line-height: 0px; overflow: hidden;"> <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px; line-height: 0px; overflow: hidden;">

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<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Firms may still compete but price competition is not in the interests of the firms as it reduces profits. <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Therefore....... <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Non-price competition rather than price competition tends to occur. <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16.363636016845703px; line-height: 1.5;">Non-price competition involves the use of advertising and marketing strategies to increase demand and develop brand loyalty among consumers. Businesses will use other policies to increase market share. examples of non price competition

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">
media type="youtube" key="n-IaCnpluVM" width="560" height="315" <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Here is an example of food retailing in S Korea. Is it an Oligopoly and is it behaving like an Oligopoly?
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Longer opening hours.
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Extended guarantees on new products.
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Better quality of service including guaranteed delivery times and free servicing. Home delivery services.
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Internet shopping
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Discounts on product upgrades.
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Free gifts and loyalty bonuses (air miles are an example)
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Advertising and Marketing
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Reward card schemes

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<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Relatively high spending on marketing is important for new business start-ups and firms trying to break into an existing market where there is consumer or brand loyalty to the existing products in the market. Advertising can also be used as a barrier to entry as new firms in order to compete must spend large amounts on advertising. They may not be able to afford this and so cannot enter the industry.

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Why is Price competition rare?
<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">A key feature of oligopolistic markets is the interdependence of price and output decisions. Firms have to consider the likely reactions of their rivals to their own pricing, output and investment strategies. This leads to uncertainty within the markets.How will other firms react to us lowering our prices? How will they react to us increasing our prices? The risk involved in changing our price may mean that prices are stable, and firms will rarely enter price competition. See this link for an explanation of Sweezy's Kinked D curve.

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<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Some industries may operate like monopolies and collude together. When this happens the existing firms decide to engage in price fixing agreements or cartels. The aim of this is to maximise joint profits and act as if the market was a pure monopoly. This behaviour is illegal, but it is hard to prove that a group of firms have deliberately joined together to raise prices. In such markets consumer welfare and economic efficiency will be very low. (For more notes on collusion and producer cartels, see below)

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Other industries may behave like a highly competitive market and from time to time price wars may break out. Firms may sacrifice profits in the short run and attempt to maximise market share (and profits) in the long run. Recent examples of price wars in markets include:


 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Supermarkets || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Personal Computers ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Low cost airlines || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Newspapers ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Mobile Phone Companies || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Mortgage Finance Markets ||

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<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Another type of oligopolistic behaviour that occurs is price leadership. This is when one firm has a dominant position in the market and the firms with lower market shares follow the pricing changes prompted by the dominant firm. We see examples of this with the major Building Societies and Petrol retailers where most suppliers follow the pricing strategies of leading firms.

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<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Price fixing represents an attempt by suppliers within a market to control supply and fix price at a level close to the level we would expect from a monopoly. In recent years we have seen the effective collapse of several high profile price-fixing agreements. Good examples to draw on would include the following:

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· The OPEC oil cartel (this is still in existence but there have been frequent tensions within the cartel – particularly when oil prices have been heading lower and leading oil producers have seen a slump in their oil export revenues and tax receipts) <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· The Coffee Export Cartel (this export-retention agreement between members of the Association of Coffee producers collapsed in April 2001 – leading in part to a further collapse in world coffee prices throughout most of 2001)

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<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">To fix prices, the producers in the market must be able to exert control over supply. This price is agreed among the members of the cartel and market supply is allocated on the basis of a quota system. Although the cartel as a whole is maximising profits, the individual firm’s output quota is unlikely to be at their profit maximising point. For this firm, expanding output can achieve extra profits. Unfortunately if one firm does this, it is in each firm’s interests to do the same, and the Cartel would collapse.

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Collusion (be it formal as in a Cartel, or informally without any written agreement in the example of price leadership) in a market is easier to achieve when

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· There are only a small number of firms in the industry <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· The industry has entry barriers – the entry of new firms reduces the power of cartels (coffee has suffered here <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Demand fairly inelastic with respect to price. ( so restricting Supply results in higher prices- this is why OPEC is so successful) <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Each firm’s output can be easily monitored – this enables the cartel more easily to control total supply and identify firms who are cheating on output quotas <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Price discounts are hard to deliver - making it more difficult for firms to deliberately under-cut their rivals and therefore break the cartel agreement

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<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Most cartel arrangements experience difficulties and tensions along way on occasions, producer cartels collapse completely. Several factors can create problems within a collusive agreement between suppliers:

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Falling market demand during an economic slowdown or recession creates excess capacity in the industry <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· The successful entry of non-cartel firms into the industry undermines the cartel’s control of the market <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Exposure of illegal price fixing by the Government or other regulators – see the example below of the fines imposed on vitamin producers by the European Commission in the autumn of 2001 <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Over-production and excess supply (e.g. arising from cheating on agreed output quotes) that breaks the price fixing agreement

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<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">In November 2001, the European Competition Commission fined eight companies a total of €855 million for participating in eight distinct secret market-sharing and price-fixing cartels affecting vitamin products. The companies are thought to have cost shoppers millions of pounds, by carving up the market and rigging prices for vitamins included in everything from cereals, biscuits and drinks to animal feed, pharmaceuticals and cosmetics. Because Swiss-based company Hoffman-La Roche was an instigator and participated in all the cartels it was given the highest cumulative fine of €462 million.

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Under tough new European Union law, companies found guilty of antitrust practices can be fined up to 10% of their total annual sales. Consumer groups in Britain welcomed the fines, which they hoped would hasten the implementation of laws proposed in the Enterprise Bill to curb anti-competitive behaviour. The Consumers' Association described the secret vitamin cartel as "corporate mugging".

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Brussels has been unable to calculate the increased cost passed on to consumers, but it does give one example relating to vitamin C. During the last year in which the cartel was in place the total value of the market was €250 million, a figure that fell by more than half to €120 million three years later.

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">The participants in each of the cartels:

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Fixed prices for the different vitamin products and allocated sales quotas <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">· Agreed on price increases and issued price announcements in accordance with their agreements

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">According to the Commission, the prime mover and main beneficiary of the vitamin cartels was Hoffmann-La Roche, the largest vitamin producer in the world, with some 50% of the overall market. The cartel arrangements covered its full range of vitamin products.

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 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Characteristic || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Perfect competition || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Oligopoly || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Monopoly ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Number of firms || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Many || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Few || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">One ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Type of product || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Homogenous || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Differentiated || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Limited due to lack of competition ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Barriers to entry || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">None || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">High || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">High ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Supernormal short run profit || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Yes || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">yes || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">yes ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Supernormal long run profit || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">No || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">yes || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">yes ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Pricing || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Price taker || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Price maker || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Price maker ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Non price competition || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">no || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">yes ||  ||
 * <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Economic efficiency || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">High || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Low || <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Low ||

=<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">This is a difficult topic. If you are struggling with it have a look at this nice simple video that summarises the main points =

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">media type="file" key="Episode 30_ Oligopoly.mp4" width="570" height="570"

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">Extension reading: <span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 16px;">

<span style="font-family: &#39;Trebuchet MS&#39;,Helvetica,sans-serif; font-size: 18px;">Applied Oligopoly media type="custom" key="28265811"