Presentation on theme: "Oligopoly. Important Facts Definition: A market dominated by a very few sellers who account for a large proportion of output. Interdependence: When the."— Presentation transcript:
Important Facts Definition: A market dominated by a very few sellers who account for a large proportion of output. Interdependence: When the actions of one firm has an effect on its competitors. There are 2 different types of oligopoly, non-colluding oligopoly and colluding oligopoly
Collusive Oligopoly Definition: Happens when several large firms work together to limit price or output. Their cooperation helps them to maintain their product at a price that is satisfying to all of the firms in the cartel. Cartel: An organization created by several firms selling the same goods or services, to control supply in an effort to manipulate prices. The most common form of collusion is known as tacit collusion. Tacit collusion occurs when several firms take actions that are not likely to cause competitive response. For example, avoiding price cutting or attacking each others markets.
Example of Tacit Collusion An example of Tacit collusion can be seen in the following article: http://www.bbc.co.uk/news/business-16540678http://www.bbc.co.uk/news/business-16540678 In this short article, we find that the following is a negative side of tacit collusion. The 2 companies accused in this article were LG and Samsung Electronics, both major electronic appliance suppliers in South Korea. The Korean Duopoly were charged a total of 44.6 Billion Won for allegedly holding secret meetings to agree on prices for washing machines, flat-panel TVs, and laptop computers.
As we can see, in a collusive oligopoly, price is set at P1, above AC1 (average cost 1), thus presenting the colluding firms with an abnormal profit. AC1 represents the average costs for the production of Q1 amount of goods or services. Profit maximizing is determined by finding the intersection between Marginal Cost and Marginal Revenue.
Non Colluding Oligopoly Definition: When major firms in an industry do not choose to cooperate and interdependence is observed. To avoid price wars, firms tend to not manipulate the pricing of their products in an oligopoly. Firms can choose to improve their sales by product awareness (i.e. advertisements) and various other means (e.g. incentive programs). Firms tend to result in non-price competition avoiding the risk of price wars. Price wars are generally avoided because if a firm lowers their price, other firms will also lower their prices, thus causing firms to lose profit.
The above is a kinked demand curve observed in non colluding oligopolies. As we can see in the graph above, demand will change from initially elastic to more inelastic. The inelasticity of demand is the reason why firms avoid price wars. Even if the firms decrease their prices, there will be not much change in sales as the demand is inelastic, resulting in the firm making a loss. We also can see that even with a decrease in MC to MC, the marginal revenue gained is still on point A and point B respectively, which both lie on MR1, meaning Marginal Revenue is still the same even though there is a decrease in Marginal Costs.
Oligopoly Graph further explained An oligopoly will face a downward sloping demand curve, however the elasticity of the demand curve depends on the reaction of rivals to the changes in price and output. The following are reasons why the Demand curve has both an elastic and inelastic curve for the graph of Non-Collusive Oligopolies. If rivals do not follow a price increase by a firm, the demand will remain fairly elastic and the firm that raised the price would end up with a decline in total revenue. If rivals react to the price decrease by a firm, the demand will remain fairly inelastic and the price drop would result in a decline in total revenue as well.
Contestable Market Oligopoly In a contestable Market, there must be low barriers to entry and exit, so that new suppliers can come in to provide fresh competition. Although no market is perfectly contestable, all markets are virtually contestable to a certain degree, save for pure monopolies. There are 3 main conditions for pure market contestability: Perfect Information and the ability of all suppliers to utilize the best available production technology. The freedom to advertise and enter a market with a competing product. The non existence of sunk costs (i.e. costs that have been committed by other firms cannot be recovered once a firm enters the industry.
P1 is the price that a pure monopoly would most likely charge, to maximize profits. When the market is contestable, the presence of abnormal profits will draw more competitors hence some profit will be competed away. Normal profit equilibrium occurs when average revenue is equal to average total cost. A lower price and higher output causes an increase in consumer supplies. When markets are contestable it is expected that there will be lower profit margins than when a monopoly has no competition.
Article #1 http://web.ebscohost.com/ehost/detail?sid=78748d98-e0b3- 4215-a78d- be36ba1d0eed%40sessionmgr111&vid=1&hid=126&bdata=Jn NpdGU9ZWhvc3QtbGl2ZQ%3d%3d#db=ulh&AN=34265491 http://web.ebscohost.com/ehost/detail?sid=78748d98-e0b3- 4215-a78d- be36ba1d0eed%40sessionmgr111&vid=1&hid=126&bdata=Jn NpdGU9ZWhvc3QtbGl2ZQ%3d%3d#db=ulh&AN=34265491 This article describes the oligopoly forming between 2 interconnected firms, the oil producers and the oil refiners. The duopoly (2 oligopolies dominating an entire industry) OPEC and Big Oil provides the oil that everybody needs. The article also talks about the oligopoly that is created by the oil refiners. It is observed that the price of crude oil has more than doubled within a year.
Analysis of Article As mentioned in the previous slide, this article deals with the existence of 2 oligopolies (not duopolies) that are interrelated, oil firms and oil refiners. The article talks about several large firms that provide Oil (OPEC and Big Oil) and oil refineries (e.g. ExxonMobil). The oil refineries are collusive Oligopolies, because they form cartels. A barrel of oil costs $140 when it was $60 a year ago, hence this oligopoly is colluding to achieve the maximum price for the maximum revenue. To stop this oligopoly from making the price too high, anti trust programs can be used to break up the cartel and price will gradually drop as the result.
Article #2 http://web.ebscohost.com/ehost/detail?sid=d47248ed-4c08- 4d94-883b- 0300bbb3e4ef%40sessionmgr114&vid=1&hid=126&bdata=Jn NpdGU9ZWhvc3QtbGl2ZQ%3d%3d#db=ulh&AN=89179515 http://web.ebscohost.com/ehost/detail?sid=d47248ed-4c08- 4d94-883b- 0300bbb3e4ef%40sessionmgr114&vid=1&hid=126&bdata=Jn NpdGU9ZWhvc3QtbGl2ZQ%3d%3d#db=ulh&AN=89179515 This article is about the oligopoly created by airlines in Canada. It talks about several new airlines branching out in Canada, and how these airlines are trying to compete for passengers. Non-price competition is observed in this article, and its obvious the firms are trying to avoid a price war. Though the pricing for air tickets are different for each firm, there is no sign of price wars and the competition observed in this article is non-price competition.
Analysis of Article The article talks about how the mergence of several new airlines in the airline industry. This industry represents an oligopoly in a contestable market. There are already several firms in the airline industry and each airline has its own pricing. Some airlines also share the same destination, however each airline has its own way to attract customers. According to Oligopoly theories, since the airline industries are in a contestable market, in order to keep their customers, industries will have to come up of ways to maintain their customers or attract more customers. Possible ways to attract more customers range from air points (incentive programs) to advertising their services.
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