OligopolyPrice 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. ³Competition amongst the few´ High level of market concentration ± Concentration ratio is the market share of the leading firms Each firm tends to produce branded / differentiated products 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 Petrol Retailing National Food Retailers Hotel Industry DIY Retail Sector Electrical Retailing Package Holiday Companies Leading Commercial Banks Telecommunications Industry Pharmaceutical companies Soft drinks manufacturers Low cost airlines Computer games console manufacturers Orange competes in an oligopoly ± there is intense price and non-price competition for customers Take any one of these business areas and see if you can name the top 5 companies! 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 K National Food Retailing 30 26.4 25 Pe Cent Ma ket Sha e What¶s the concentration ratio of top 3? Or the top 5? 20 18.8 14.6 10.5 15 10 6.1 5 3.6 3.2 2.2 0 esco Sainsbur Asda Safewa William Morrison Somerfield Iceland Kwik Sa e Fou Weeks to 31st Ma c 2002 ¢ ¡ ¡ The Concentration Ratio in Hotels Market Share in the United Kingdom Hotel Sector es t Wes tern Whit rea Co as s Si Continents Mac onald Corus & Regal Choic e Hilton Jar is c c or This tle Hotels Moat Hous e 18.5 10.7 10.2 6 5.1 4.9 4.6 .6 3.5 3.1 2.4 3 firm concentration ratio = 49.4% 5 firm concentration ratio = 65.6% 7 firm concentration ratio = 75.6% Measuring the Concentration Ratio in Clothes Retailing Mar s an Spencer Arcadia ext ebenha s George @ As a Bhs Matalan ew Look ouse o raser John Lewis 3 Firm oncen ra ion 5 Firm oncen ra ion 7 Firm oncen ra ion a io a io a io 1996 13 6 34 37 16 25 07 11 16 12 22 4 27 7 30 9 2000 10 5 1 52 39 6 21 19 17 16 14 23 8 30 3 34 3 Old da a alert!!!! Principal still applies though! 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 Petrol retailing The Burger market Personal Computers Broadband internet services Package holiday industry Mobile Phone Companies Mortgage Market Car and home insurance Can you think of some ¶pricing· strategies that these businesses tend to use? 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 market share MR1 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 Q1 MR1 Output 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 Q1 MR1 Output 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 Reducing price below P1 Demand is relatively inelastic Little gain in market share ± other firms have followed suit Total revenue may still fall AR1 Q1 MR1 Output 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 Price An increase in raw material prices causes an upward shift in the 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