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Chapter 12 - Oligopoly Types of market 1. 2. 3. 4. Perfect competition Imperfect competition Oligopoly Monopoly Eg. Fruit and vegetable vendors in local markets Eg. Restaurants, hotels, pubs and hairdressers Eg. Broadband companies, supermarkets, petrol companies, banks Eg. An Post, Dublin Bus, Iarnrod Eireann Characteristics of an oligopoly Barriers to entry exist Firms engage in product differentiation Firms are interdependent There are a few number of large firms producing similar goods Non price competition occurs Collusion may occur Barriers of entry are factors which prevent or deter new suppliers or firms from entering a market Price rigidity (sticky prices) the tendency for prices not to chance, even if the firm’s costs change, in order to avoid reactions from competitors The kinked demand curve When a firm increases prices others will not follow as increasing prices leads to a big fall in Qd When a firm decreases prices, others will be forced to follow, to prevent a fall in Qd This leads to rigid prices and a kink in the demand curve P A A B Elastic A-B Inelastic B-C See below to explain the kinked demand curve From A → B (the firm faces an elastic demand curve) C Q A firm increases its prices, other firms will keep their prices the same A The firm who increased their prices will lose customers to rival firms (producing close substitutes) An increase in price will cause a major decrease on Qd and profits From B → C (the firm faces an inelastic demand curve) A firm decreases its prices, other firms will be forced to lower their prices too With all firms lowering their prices, the market share for all firms will remain relatively unchanged All firms lose out as they have all lowered prices, leading to less profit being made Hence oligopolists will be reluctant to change prices at all Price leadership - occurs when one firm is in a dominant position and decides the price it will charge and smaller rivals will follow their lead If the price leader raises prices, other firms will follow because they feel a price war would be self defeating in the LR If the price leader lowers prices, other firms will follow because otherwise they would lose customers to the price leader Equilibrium of a firm under oligopoly P MC A AC B P1 D E F C AR = D MR MC Q1 Q SNP’s to be eared in the long run as AR > AC and barriers to entry exist eg. high start up costs, patents which prevent new firms from joining the industry The firm sells at a price of P1 and the firm produces at a quantity of Q1 Equilibrium occurs at point E, where MR = MC, and MC is rising faster than MR Cost of production occurs at point E. Should costs rise between D and F, the market price will remain constant at P1, as firms wish to avoid a price war The firm is making efficient use of scarce resources, as they are producing at the lowest point on the AC curve Collusion where rival firms work together for their mutual benefit Types of collusion 1. 2. 3. 4. Pricing policy / limit pricing - reducing or limiting prices to keep other firms out Output policy / limit production - limit output to an agreed amount to keep Qs down and Qd up Sales territories - divide up the market between them, agreeing not compete outside their territories Implicit collusion - each firm recognises that by behaving as if they were branches of one single firm, their profits will be higher ie. Individual firms do not price cut Baumol model of sales maximisation This theory states that sales maximisation is the desired goal of managers Target level of profits Q1 Qm Q2 Level of profits When Qm is produced, the firm has produced output that will maximise profit When Q1 is produced, target profits are earned with the minimum output needed. This may be a business where the owner does not aggressively pursue profit maximisation, When Q2 is produced, target profit is being earned and sales are maximised