Revision:Oligopoly

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In an oligopoly there are a few big firms in the industry. Features:

1. Interdependence - each firm influences and is influenced by the other firms in the market.
2. High concentration ratio - e.g. 99% for cigarettes.
3. High MES - a high MES suggests that a firm has
   1. Economies of scale
   2. Standardisation of product
   3. Mass production
4. Barriers to entry and exit
5. Brand proliferation - one producer is able to capture many segments of the market this way e.g. detergent.
6. Price wars - may be subsidised by using profits from another source e.g. Murdoch used profits from Sky to subsidise The Times when launching a price war against The Independent.
7. Non price competition - increasing market share without changing price. This can take the form of
   1. Persuasive advertising
   2. Quality of service
   3. Loyalty schemes
   4. Free gifts (e.g. in magazines)
   5. Packaging
   6. Temporary price reductions

Kinked demand curve

A kinked demand curve

Above the current market price, demand is elastic because the firm would lose most of its custom. Below the current market price, demand is inelastic, because if the firm tried to lower it prices, every other firm in the industry would follow suit. Therefore the firm is unable to change the price of its goods without suffering a loss of revenue.

The vertical discontinuity is another reason for price rigidity. Costs may change radically along the discontinuity without having an effect on the profit maximising price.

Criticism

This model has been criticised because it does not offer an explanation as to how the price reached its current level.

Collusion

Oligopolists are able to collude to keep prices artificially high. This is against the public interest as consumers lose out on consumer surplus. Collusion can take three forms:

1. Cartels - firms make formal agreements with other firms. Illegal under the 1998 Fair Trading Act in the UK.
2. Secret collusion - a price fixing agreement e.g. cement firms. Illegal.
3. Tacit collusion - unspoken collusion. Not subject to law. Price leadership where one firm is the acknowledged leader and other firms follow.

Necessary conditions for collusion:

• Few producers - collusion can't work when there are lots and lots of firms!
• Barriers to entry
• Production quotas set with no cheating
• No substitutes
• Demand is increasing or stable

The obvious benefit to producers is high abnormal profits in the short run. However there may be disadvantages:

• Danger of fines e.g. BA/Virgin
• Poor public image

Collusion reduces consumer surplus by increasing the price of goods. Output may be lower.

If you need anymore help, here are some useful notes for IB economics: [1]

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