Oligopoly

Price and output under oligopoly

A2 Economics
Key Issues

• Meaning of oligopoly
• Interdependence between producers
• Importance of uncertainty within this market structure
• Examples of oligopoly
• Price and non-price competition
• The kinked demand curve
• Price and output under conditions of oligopoly
What is an Oligopoly?

• Oligopoly is best defined by the market conduct

(behaviour) of firms
• A market dominated by a few large firms I.e.
“Competition amongst the few”
• High level of market concentration
– Concentration ratio is the market share of the
leading firms
• Each firm tends to produce branded
ey is s u/e is
K
ur of a few!
differentiated products behavi
o
What is an Oligopoly?
• Entry barriers – long run supernormal profits
• Mutual interdependence between competing
firms (important)
• Intensive non-price competition is common
• Periodic aggressive price wars
• Strong tendency for many market structures to
tend towards oligopoly in the long run
– Market consolidation
– Exploitation of economies of scale
Examples of Oligopolies
Take any one of these
• Petrol Retailing
• National Food Retailers
business areas and see if
• Hotel Industry you can name the top 5
• DIY Retail Sector companies!
• Electrical Retailing
• Package Holiday Companies
• Leading Commercial Banks
• Telecommunications Industry
Orange competes in an oligopoly –
• Pharmaceutical companies there is intense price and non-price
• Soft drinks manufacturers competition for customers
• Low cost airlines
• Computer games console
manufacturers
To name a few examples of oligopolies
• Groceries - dominated in India by RelianceMart, Subiksha, BigBazaar and
FoodWorld
• Chemicals/oils - wide definition of the term chemical but key players are Indian
Oil Corporation, ONGC, Bharat Petroleum, Oil India Limited, BASF India, Flex,
Tata Chemicals, Jubilant Organosys
• Brewers - UB brands (Kingfisher, Zingaro and Kalyani Black) have a 48 % market
share, SAB's acquired brands (Haywards, Royal Challenge, Knock Out and
Foster's) deliver a combined market share of 37%, all others are limited to the
remaining 15%
• Fast food outlets - McDonalds, Nirulas, KFC, Pizza Hut
• Detergents – Fena, Ghari Group, Karnataka Soaps & Detergents, Nirma and
Proctor and Gamble
• Music retailing – Saregama India Limited, TIPS Industries, Times Music
• Banks – SBI, HDFC, Citibank, ICICI
• Entertainment – Sony Pictures, Zee Telefilms, Cinevistas, Balaji Telefilms
• Electrical retail – NDPL, BSES,
• Electrical goods – Seimens, Crompton Greaves, Tullu Pumps, Wipro Lightning.
• Mobile phone networks – Bharti Airtel, Reliance, Vodaphone, Idea, BSNL
Market Share in Food Retailing

UK National Food Retailing What’s the

concentration ratio of
30
26.4
top 3?
25 Or the top 5?
Per Cent Market Share

20 18.8

14.6
15

10.5
10

6.1
5 3.6 3.2
2.2

0
Tesco Sainsbury Asda Safeway William Somerfield Iceland Kwik Save
Morrison
Four Weeks to 31st March 2002
The Concentration Ratio in Hotels

Market Share in the United Kingdom Hotel Sector

Best Western 20.2
Whitbread 18.5
Compass 10.7 3 firm concentration ratio
Six Continents 10.2
MacDonald 6 = 49.4%
Corus & Regal 5.1
Choice 4.9
5 firm concentration ratio
Hilton 4.6
= 65.6%
Jarvis 3.6
Accor 3.5 7 firm concentration ratio
Thistle Hotels 3.1
Moat House 2.4 = 75.6%
Measuring the Concentration Ratio in Clothes Retailing

1996 2000
Marks and Spencer 13 10.5 Old data
Arcadia 6 8.1 alert!!!!
Next 3.4 5.2
Debenhams 3.7 3.9
Principal
George @ Asda 1.6 2.6
still applies
Bhs 2.5 2.1 though!
Matalan 0.7 1.9
New Look 1.1 1.7
House of Fraser 1.6 1.6
John Lewis 1.2 1.4
3 Firm Concentration Ratio 22.4 23.8
5 Firm Concentration Ratio 27.7 30.3
7 Firm Concentration Ratio 30.9 34.3
So what’s the problem with a high concentration ratio?

• You need to think back to arguments against monopolies.

Concentration ratio & market share

• Market forms can often be classified by their concentration ratio.

Listed, in ascending firm size, they are:

• Perfect competition, with a very low concentration ratio.

• Monopolistic competition, below 40% for the four-firm

measurement.

• Oligopoly, above 40% for the four-firm measurement.

• Monopoly, with a near-100% four-firm measurement.

Price Wars in Oligopolistic Markets

• Price wars are concerned with raising or defending market share

• Firms depart from short run profit maximization when they engage in
price wars – but can return to this in the long run
• They often happen after a period of relative price stability or when
new firms enter the market
• Low cost airlines
Can you think of some
• Petrol retailing
‘pricing’ strategies that
• The Burger market
these businesses tend to
• Personal Computers
use?
• Broadband internet services
• Package holiday industry
• Mobile Phone Companies
• Mortgage Market
• Car and home insurance
Importance of Non Price Competition
• Non price competition involves
– Use of advertising and marketing strategies to increase
demand and develop brand loyalty
– Other policies to increase market share
• guaranteed delivery times
• longer opening hours

• Advertising spending runs in £ millions for many firms

– Some firms apply the profit maximising rule to advertising
– Others see advertising as a way of increasing revenue
– Important for new business start-ups
– Seen as a barrier to entry by incumbent businesses
Non-Price Competition in Food Retailing
• Traditional advertising / marketing
• Loyalty cards
• Banking and other Financial Services
• In-store chemists / post offices /
• Home delivery systems
• Discounted petrol
• Extension of opening hours (24 hour shopping)
• Innovative use of technology for shoppers
• Incentives to shop at off-peak times
• Internet shopping
The Kinked Demand Curve
One model of price and output determination
The Kinked Demand Curve

Price Rival firms assumed to follow a price cut

(making demand relatively inelastic)
but
firms are assumed not follow a price
increase (making demand relatively
elastic)

AR1
AR2

Assumes the main aim of

the firm is to maintain MR1
market share

Output
MR2
Deriving the Kinked Demand Curve

Price

Assume we start out at P1 and Q1:

Will a firm benefit from raising price above P1?
Will it benefit from cutting price below P1?

P1

AR1

Output
Q1

MR1
Deriving the Kinked Demand Curve

Price Raising price above P1

Demand is relatively elastic
Firm loses market share
and some total revenue
Assume we start out at P1 and Q1:
Will a firm benefit from raising price above P1?
Will it benefit from cutting price below P1?

P1

AR1

Output
Q1

MR1
Deriving the Kinked Demand Curve
Price Raising price above P1
Demand is relatively elastic
Firm loses market share
and some total revenue
P1
Q1
Assume we start out at P1 and Q1:
Will a firm benefit from raising price above P1?
Will it benefit from cutting price below P1?
Reducing price below P1
Demand is relatively inelastic
Little gain in market share –
other firms have followed suit
Total revenue may still fall
AR1
Output
MR1
Profit Maximisation?

Price If MC curve for the first cuts through the

discontinuity in the MR curve – does this
mean that the firm is maximizing profits?

MC

AR

Output

MR
A Rise in Marginal Costs

An increase in raw material prices causes an upward shift in the

Price firm’s marginal cost curve
With a kinked demand curve (and discontinuity in the MR curve)
there may be no change in the profit maximizing price and output
MC2
MC1

AR

Output

MR
Oligopoly Pricing

• Four major theories about oligopoly pricing:

– Oligopoly firms collude to charge the monopoly price
– Oligopoly firms compete on price so that price and profits
will be the same as a competitive industry
– Oligopoly price and profits will be between the monopoly
and competitive ends of the scale
– Oligopoly prices and profits are "indeterminate" (oligopoly
seen as difficult to model)
• In reality the pricing strategies for businesses within an
oligopoly can be expected to change over time