Oligopoly

Defining and measuring oligopoly

market structure (2017 data).

Concentration ratios

Example of a hypothetical concentration ratio

Examples

Fixed Broadband services

(2015). Source: OFCOM

Fuel retailing

Further examples

Cinema attendances Banking

The Herfindahl – Hirschman Index (H-H Index)

^{2 2 2} regulation

Key characteristics

Interdependence

Texaco game theory Prisoner’s Dilemma

Strategy

• Whether to compete with rivals, or collude with them.
• Whether to raise or lower price, or keep price constant.
• Whether to be the first firm to implement a new strategy, or whether to wait and see what rivals do. The advantages of ‘going first’ or ‘going second’ are respectively called 1st and 2nd-mover advantage. Sometimes it pays to go first because a firm can generate head-start profits. 2nd mover advantage occurs when it pays to wait and see what new strategies are launched by rivals, and then try to improve on them or find ways to undermine them.

Barriers to entry

barriers to entry

Natural entry barriers include:

Economies of large scale production.

economies of scale

Ownership or control of a key scarce resource

High set-up costs

sunk costs

High R&D costs

Artificial barriers include:

Predatory pricing

Limit pricing

Limit pricing average total costs

Superior knowledge

Predatory acquisition

Competition and Markets Authority (CMA)

Advertising

sunk cost

A strong brand

Loyalty schemes

Exclusive contracts, patents and licences

Vertical integration

Sony Netflix ABQ Pinewood studio

Collusive oligopolies

monopoly

Types of collusion

Overt

Covert

Tacit

in concert'

Competitive oligopolies

Pricing strategies of oligopolies

1. Oligopolists may use predatory pricing to force rivals out of the market. This means keeping price artificially low, and often below the full cost of production.
2. They may also operate a limit-pricing strategy to deter entrants, which is also called entry forestalling price.
3. Oligopolists may collude with rivals and raise price together, but this may attract new entrants.
4. Cost-plus pricing is a straightforward pricing method, where a firm sets a price by calculating average production costs and then adding a fixed mark-up to achieve a desired profit level. Cost-plus pricing is also called rule of thumb pricing.There are different versions of cost-pus pricing, including full cost pricing, where all costs - that is, fixed and variable costs - are calculated, plus a mark up for profits, and contribution pricing, where only variable costs are calculated with precision and the mark-up is a contribution to both fixed costs and profits.

game theory

Non-price strategies

1. Trying to improve quality and after sales servicing, such as offering extended guarantees.
2. Spending on advertising, sponsorship and product placement - also called hidden advertising – is very significant to many oligopolists. The UK's football Premiership has long been sponsored by firms in oligopolies, including Barclays Bank and Carling.
3. Sales promotion, such as buy-one-get-one-free (BOGOF), is associated with the large supermarkets, which is a highly oligopolistic market, dominated by three or four large chains.
4. Loyalty schemes, which are common in the supermarket sector, such as Sainsbury’s Nectar Card and Tesco’s Club Card.

1. How successful is it likely to be?
2. Will rivals be able to copy the strategy?
3. Will the firms get a 1st - mover advantage?
4. How expensive is it to introduce the strategy? If the cost of implementation is greater than the pay-off, clearly it will be rejected.
5. How long will it take to work? A strategy that takes five years to generate a pay-off may be rejected in favour of a strategy with a quicker pay-off.

Price stickiness

stick

Kinked demand curve

kinked current

Maximising profits

A game theory approach to price stickiness

game theory

• Raise price
• Lower price
• Keep price constant

The Prisoner’s Dilemma

cartels mutual interdependence

1. Higher prices or hidden prices, such as the hidden charges in credit card transactions
2. Lower output
3. Restricted choice or other limiting conditions associated with the transaction

Prisoner's Dilemma

Examples of Oligopoly

banking supermarkets music

Evaluation of oligopolies

The disadvantages of oligopolies

1. High concentration reduces consumer choice.
2. Cartel-like behaviour reduces competition and can lead to higher prices and reduced output.
3. Given the lack of competition, oligopolists may be free to engage in the manipulation of consumer decision making. By making decisions more complex - such as financial decisions about mortgages - individual consumers fall back on heuristics and rule of thumb processes, which can lead to decision making bias and irrational behaviour, including making purchases which add no utility or even harm the individual consumer.
4. Firms can be prevented from entering a market because of deliberate barriers to entry.
5. There is a potential loss of economic welfare.
6. Oligopolists may be allocatively and productively inefficient.

A

The advantages of oligopolies

1. Oligopolies may adopt a highly competitive strategy, in which case they can generate similar benefits to more competitive market structures, such as lower prices. Even though there are a few firms, making the market uncompetitive, their behaviour may be highly competitive.
2. Oligopolists may be dynamically efficient in terms of innovation and new product and process development. The super-normal profits they generate may be used to innovate, in which case the consumer may gain.
3. Price stability may bring advantages to consumers and the macro-economy because it helps consumers plan ahead and stabilises their expenditure, which may help stabilise the trade cycle.

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