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You are expected to explain/analyze (AO2) the characteristics of an oligopoly, draw (AO4) the collusive oligopoly diagram, and evaluate/examine (AO3) allocative efficiency in an oligopoly, game theory, types of oligopoly competition, and market concentration (HL)
Characteristics of an Oligopoly (AO2)
Characteristics of an Oligopoly (AO2)
A oligopoly is a market structure with the following characteristics:
A few firms controlling most of the market
Differentiated products: The goods and services the firms offer are different from each other
Large barriers to entry
Market power: Since there are only a few firms, each has quite a lot of control over the market
Firms are price makers: Given their market power, they have the ability to choose their own prices and not the market equilibrium price
Interdependence amongst the firms: Because there are only a few firms, their actions affect the other firms' actions. This can lead to a couple of scenarios:
Price wars: The firms try and undercut each other, leading to unsustainably low prices
Collusion: The firms decide to increase prices together, leading to very high prices
Cheating: Despite laws preventing firms from colluding, they might still do so in order to make lots of abnormal profit
Collusive Oligopoly Diagram (AO4)
Collusive Oligopoly Diagram (AO4)
There are 2 types of oligopoly:
Collusive: The firms decide to team up and set similar prices, so they all benefit from higher prices
Non-collusive: The firms do not team up, and compete against each other
The diagram for non-collusive oligopoly is quite complicated but luckily you don't need to know it :) Only the collusive oligopoly diagram is listed on the syllabus, and is essentially identical to the monopoly diagram:
Allocative Efficiency (AO3)
Allocative Efficiency (AO3)
In a collusive oligopoly, the firms decide to team up and essentially act as a single entity, a monopoly.
This means they have the market power to set produce their profit maximizing quantity, meaning allocative efficiency is not reached.
This leads to welfare loss, identical to a monopoly's ->
Game Theory Payoff Matrix (AO3)
Game Theory Payoff Matrix (AO3)
A collusive oligopoly can only happen when the firms decide to team up and actually go through with it. What if one firm decides to betray the other, in an attempt to make more money? Or what if they both think that way?
This situation can be explained using a game theory matrix (use the arrow buttons for explanation):
Competition in Oligopolies (AO3)
Competition in Oligopolies (AO3)
Oligopolies can compete in two different ways:
Price Competition: This is the obvious one, where the different firms try and make the price of their products as appealing as possible
Non-price Competition: Firms can also compete in other variables, such as quality, design, aesthetics, and trends. This is possible because an oligopoly has differentiated products, in contrast to a perfect competition.
Market Concentration (AO3)
Market Concentration (AO3)
The market concentration of an industry refers to the distribution of the firms in the given market.
If there are very few firms, there is a high market concentration
If there are many firms, there is a low market concentration
A market concentration can be measured using a concentration ratio - The market share a specified number of firms (usually 5) have over an industry. Here is an example:
In Bangladesh, the top 3 telecom companies control 43.8%, 30.2%, and 22.4% of the market share each. If we were to add these up, we get 96.4% as a concentration ratio. This indicates the market is extremely concentrated.
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