Download - Oligopoly (Kinked Demand Curve) 2007
OligopolyPrice and output under oligopolyA2 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 / differentiated products
Key issue is
behaviour of a few!
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
UK National Food Retailing
26.4
18.8
14.6
10.5
6.1
3.6 3.22.2
0
5
10
15
20
25
30
Tesco Sainsbury Asda Safeway WilliamMorrison
Somerfield Iceland Kwik Save
Four Weeks to 31st March 2002
Per
Cen
t M
arke
t S
har
e
What’s the concentration ratio of
top 3?Or the top 5?
The Concentration Ratio in Hotels
Market Share in the United Kingdom Hotel Sector
Best Western 20.2
Whitbread 18.5
Compass 10.7
Six Continents 10.2
MacDonald 6
Corus & Regal 5.1
Choice 4.9
Hilton 4.6
Jarvis 3.6
Accor 3.5
Thistle Hotels 3.1
Moat House 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
1996 2000Marks and Spencer 13 10.5Arcadia 6 8.1Next 3.4 5.2Debenhams 3.7 3.9George @ Asda 1.6 2.6Bhs 2.5 2.1Matalan 0.7 1.9New Look 1.1 1.7House of Fraser 1.6 1.6John Lewis 1.2 1.43 Firm Concentration Ratio 22.4 23.85 Firm Concentration Ratio 27.7 30.37 Firm Concentration Ratio 30.9 34.3
Old data 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
AR1
MR1
AR2
MR2
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)
Assumes the main aim of the firm is to maintain market share
Price
Output
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?
Deriving the Kinked Demand Curve
Price
Output
P1
Q1
AR1
MR1
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?
Deriving the Kinked Demand Curve
Raising price above P1
Demand is relatively elastic
Firm loses market share and some total revenue
Price
Output
P1
Q1
AR1
MR1
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?
Deriving the Kinked Demand Curve
Raising price above P1
Demand is relatively elastic
Firm loses market share and some total revenue
Reducing price below P1
Demand is relatively inelastic
Little gain in market share – other firms have followed suit
Total revenue may still fall
Price
Output
P1
Q1
AR1
MR1
AR
MR
MC
Profit Maximisation?
If MC curve for the first cuts through the discontinuity in the MR curve – does this mean that the firm is maximizing profits?
Price
Output
AR
MR
MC1
A Rise in Marginal Costs
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
Output
Price
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