Download Monopoly - Leaving Cert Notes

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
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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
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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)
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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)
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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
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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
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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