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%


= 65.6%


= 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





Raising price above P1

Demand is relatively elastic

Firm loses market share and some total revenue

Price

Output

P1

Q1

AR1

MR1





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

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Oligopoly (Kinked Demand Curve) 2007