GCEA-LEVEL & IBECONOMICS
Transcript of GCEA-LEVEL & IBECONOMICS
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OligopolyGCE A-LEVEL&IB ECONOMICS
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WhatisOligopoly?Amarketcontrolledbyafewlargefirms.
- Highbarrierstoentryandexit◦ Duetolarge-scaleproduction(economiesofscale)orbranding/long-termstandinginthemarket
- Interdependence◦ I.e.actionsofonefirmcaneasilyaffectothers
- Non-pricecompetition◦ Duetopricerigidity,youwillseewhylater
- Differentiatedorhomogenousgoods◦ E.g.laundrypowder
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ConcentrationRatios
ConcentrationRatiosaresimplythecombinedmarketshareoftopfirms.Canyoufigureourthe3,4and5firmconcentrationratiosinthetableontherightforHongKongPrivateResidentialHousingDevelopers?
PrivateResidentialHousingDevelopers
MarketSharein2015
---------------------------ConcentrationRatioPercentage
DeveloperA 33.83%
DeveloperB 21.04%
DeveloperC 14.47% CR3 (3FirmConcentration Ratio)
DeveloperD 4.97% CR4 (4FirmConcentration Ratio)
DeveloperE 4.32% CR5 (5FirmConcentrationRatio)
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ConcentrationRatios
ConcentrationRatiosaresimplythecombinedmarketshareoftopfirms.Canyoufigureourthe3,4and5firmconcentrationratiosinthetableontherightforHongKongPrivateResidentialHousingDevelopers?
PrivateResidentialHousingDevelopers
MarketSharein2015
---------------------------ConcentrationRatioPercentage
DeveloperA 33.83%
DeveloperB 21.04%
DeveloperC 14.47% CR3 (3FirmConcentration Ratio)
69.34%
DeveloperD 4.97% CR4 (4FirmConcentration Ratio)
74.31%
DeveloperE 4.32% CR5 (5FirmConcentrationRatio)
79.63%https://www.researchgate.net/publication/317811921_Concentration_Analysis_of_New_Private_Residential_Units_Market_in_Hong_Kong?_sg=MNY8GbNcgC2X_7wp461unCrwuW7zWKvjReS7_zW8HrpGdQiWZUxkpFpaKt2ns5YlBe3TLwLiQw
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ConcentrationRatios
Aruleofthumbisthatanoligopolyexistswhenthetopfourfirmsinthemarketaccountformorethan60%oftotalmarketsales.(i.e.CR5 >60%)
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ExamplesofOligopolies
https://www.scmp.com/business/article/2050088/hong-kongs-developer-cartel-beginning-lose-its-grip
RealEstateDevelopersSupermarketChains
BigFourAccountingFirms
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Non-CollusiveOligopolyRevenues
Underanon-collusiveoligopoly,whenafirmraiseprices,otherplayerswillkeeppricesconstant.Becauseofthis,existingcustomerswillswitchtocheaperalternatives.Thismeansasmallincreaseinpricewillcausealargerfallinquantitydemanded.
Hence,upperpartsofthedemandcurveiselastic.
Price
Output
P
Q
AR=D
Priceelastic
Priceinelastic
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Non-CollusiveOligopolyRevenues
Whenafirmdecreaseprices,otherplayersareassumedtoalsodecreasepricestonotlosemarketshare.Becauseofthis,asteepdecreaseinpriceisrequiredtoattractothercustomerstobuyyourproduct.Thismeansabiggerfallinpriceisrequiredtoincreasequantitysold.Hence,upperpartsofthedemandcurveiselastic.
Price
Output
P
Q
AR=D
Priceelastic
Priceinelastic
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Non-CollusiveOligopolyRevenues
GiventheMRistwiceassteepastheAR,theMRinakinkeddemandcurvewillshapelikethis.
Noticethebreakinthemiddle–thereareactually2partstotheMRcurve,onecorrespondingtoeachARline.
Price
Output
P
Q
MRAR=D
a
b
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Non-CollusiveOligopolyDiagramThisisthediagramyouwillhavewhenyoucombinetheMCcurve.TheisnodifferenceinpriceaslongastheMCcurve‘intersects’withMRbetweenMC1andMC2
Wheredoesthefirmmaximizeprofitsagain?Youneedtobeawareoftheprofitmaximizationpointtodrawthisdiagramaccurately– thepricealwaysneedtobeatthekink.
Price
Output
P
Q
MR
MC1MC2
AR=D
a
b
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Non-CollusiveOligopolyDiagram
Thisdiagramshowstheabnormalprofitsthatcanbemadeinanoligopoly.
Price
Output
P
Q
MR
MC
AR=D
AC
C
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Non-CollusiveOligopolyDiagram
Alosscanalsobemade– thisalldependsonwheretheACandARcurveispositioned.
Price
Output
P
Q MR
MC
AR=D
AC
C
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AreOligopoliesCompetitive?
Butwhydoweassumethefirmswillcompetewitheachotherformarketsharewhenpricesfall?
Orwhywillthebigplayersalwaysaimtogainothers’marketsharewhenafirm’spricesincrease?
Wecanthinkaboutthisusingananalogy.
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ThePrisoner’sDilemma
Don’tbetray
Betray
Betray Don’tbetray
Loki
5years
5years
15years
15years
1 year
1 year 3 years
3 years
Twoprisoners(players),LokiandBaelish havebeenarrestedforbankrobberyandinterrogatedseparately.Policehaveevidenceofminorcrimesforbothprisoners.However,theyarelookingtopinamajorcrimeononeorbothoftheprisoners.Bothplayershaveevidenceoneachotherthattheytookpartinthemajorcrime.
Baelish
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ThePrisoner’sDilemma
Don’tbetray
Betray
Betray Don’tbetray
Loki
5years
5years
15years
15years
1 year
1 year 3 years
3 years
Thepolicearewillingtobemorelenientiftheprisonersprovidethemwiththisevidenceandbetraytheirpartnerincrime.Eachplayerhasastrategy – betrayordon’tbetray.
Thereisapayoff foreachstrategyundertaken.Thisisshowninthetablee.g.ifAandBbothbetraytheyeachget5yearsinprison.
Baelish
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ThePrisoner’sDilemma
Don’tbetray
Betray
Betray Don’tbetray
5years
5years
15years
15years
1 year
1 year 3 years
3 years
Thedominantstrategyisthebeststrategyundertakenbyaplayerregardless ofthestrategyundertakenbytheotherplayers.
NomatterifLokibetraysBaelish ornot,Baelish willalwaysgetlesstimeinprisonifhebetraysLoki.i.e.5yearsratherthan15 yearsifLokibetrayshim;and1yearratherthan3yearsifLokidoesn’t.Viceversa.
Loki
Baelish
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ThePrisoner’sDilemma
Don’tbetray
Betray
Betray Don’tbetray
5years
5years
15years
15years
1 year
1 year 3 years
3 years
Hencethedominantstrategyforbothofthemistobetraytheother.ThisequilibriumiswhatwecalltheNashequilibrium.
Thisisassumingthattheydidnotagreebeforehandonwhethertheyshouldbetraytheotherornot.
Loki
Baelish
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TheFirm’sDilemma
IncreaseP
MaintainP IncreasePB
A
£100
£100
£75
£75
£150
£150 £125
£125
Sowithoutaformalagreementbetweeneachother,thefirmsfacethesameproblem.
Thedominantstrategywillbetomaintainpricestokeepmarketshare.
MaintainP
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IsthereaMutuallyBeneficialOutcome?
Inreallife,firmswillbeabletocommunicatewithoneanother.
Whatcanthebigplayersintheindustrydo/agreeon,whichcanbemutuallybeneficial?
Theobjectiveofthiswillbetomaximizeandsharejointprofits intheindustry,whichwillbehigherthancompetingwitheachother.
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OvertCollusionTobenefitasagroup,thefirmscan
- Raisepricestogether(orsetthem)
- Produceanagreed,fixedamountofoutput(tomaximizeprofits)
- Splitthemarketbetweenthemselves(e.g.geographically,byproduct)
- Notpassonnewcostsavingstoconsumerstogether(e.g.fromtechnology)
Acartelisaformalagreementbetweenfirmstocolludeinthemarket.
Youcanseethecartelactslikeamonopolyandhasmuchbiggermarketpowercomparedtoafirminanoligopoly.
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CaseStudy– LaundryDetergents
MeanwhileinAustralia...
https://www.smh.com.au/business/companies/project-mastermind-colgate-colluded-with-rivals-and-woolworths-to-rip-you-off-20160428-goh9ji.html
Unilever,ColgateandSupermarketChainWoolsworth colludingnottopasscostsavingsfromproductinnovationtocustomers,throughpricefixingandoutputrestrictions.
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TacitCollusion
However,notalltypesofcollusionincludeaformalagreement(cartel)betweenthefirms.Theycanalsodoitinanimplicitmanner.Thisiswhatwecalltacitcollusion.
Forexample,firmsmaychargethesamepricesasthedominantfirmintheindustry(insteadofchallengingit).Thefirmwithpriceleadership willchargeahigheramountforotherfirmstofollowsuit,suchthatthewholeindustrybenefitswithhigherprofitsbutconsumersloseout.
Thisisascenariowhereanimplicitpriceagreementisinplace.
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TheRisksofCollusion
1.Betrayal/CheatingfromotherPlayers
- Otherfirmsinthemarketmaynotcontinuewiththeagreement.Forexample,ifanagreementisreachedtoraiseprices,ifaplayerdoesnotfollowthrough,hewillbeabletogainmarketshareforhimselfandreducerevenuesforotherplayers.
2.RegulationandFines
- Thereislegalriskespeciallyforanovertcollusiveagreementbetweenfirms.Theycaneasilybepenalizedaheftyfine.Also,therewillbetheriskofafirmwhistleblowingtotheindustryregulatorfortheactivity.
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TheRisksofCollusion
3.PublicRelationsandBranding
- Collusion,whendiscovered,willharmthepublicimageoffirms.Publicimageandbrandingisanintangibleassetthatcanbequitevaluabletoafirmgiventheimportanceofnon-pricecompetitionwithinanoligopolisticmarketstructure.
However,whenfirmscollude,itismostlikelythattheserisksaretakenintoaccountandtheexpectedprofitsmaximizedandsharedfromcollusionmaybehigherthanpotentiallosses.
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PriceCompetitioninanOligopoly
Whydo youthinkoligopolieswouldnotfavorprice-basedcompetitionandwouldexhibitpricerigidity?
P
Q
MR
MC1MC2
AR=D
a
b
Price
Output
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PriceCompetitioninanOligopoly
Pricewarsoccurwhenafirmlowerspriceinordertoincreasemarketshare.Otherfirmswillreacttolosingmarketsharebyloweringpricetoo.Thiswillcontinueasfirmsseektoregainlostmarketshare.Theconsumerwillbenefitfromlowerpricesbuttheoligopolists willloseoutasoverallrevenueswillfall.
Hence,inanon-collusiveoligopoly,pricesshouldbestableandrigidaccordingtotheoryandthediagram.
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TypesofNon-priceCompetition
Assuminganoligopolydoesnotcolludeorworkwithoneanother,theywillcompetewitheachotherintermsofnon-pricefactors.Thereasonisthatcompetingonpricewillreducerevenuesandlikelyaffectprofits.
Whatdoyouthinkaresomewayswhicholigopolisticfirmscancompete,notonthebasisofprice?
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TypesofNon-priceCompetition
Advertising isanexampleofasunkcostanddetersnewentrants
Firmswillspendheavilytryingtoestablishbrandloyalty andrepeatcustomerse.g.loyaltyschemes
Byinvestinginnewproductdevelopmentthefirmcanincreasedemandandmaintainbrandloyalty
Heavyinvestment undertakenwillhavehighlevelsofcapitalinvestmentinoligopoly, leadingtoasteadyincomestreamforthefuture
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EvaluatingOligopolies
Howwouldyouevaluateoligopolies?Towhatextentaretheybeneficialorharmfultosociety?
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EvaluatingOligopoliesAdvantages:
- Generallystablepricesforconsumersandproducersdownthevaluechain
- Researchanddevelopmentthroughnon-pricecompetitionwillleadtoproductinnovation
- Canbenefitfromeconomiesofscalewhilepassingonlowerpricestoconsumerstosomedegree
Disadvantages:
- Risksofcollusionmaycauseconsumerstoloseoutinthelongrun
- Difficulttoregulateandprovetacitcollusionthroughpriceleadership(hardtoarguewhatisasuitablepricepointsgivendifferentcoststructuresacrossfirms)
- Notthemostefficienttypeofmarketstructurepossibleduetoprofitmaximization
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ShortQuestions- Oligopoly
- Suggest3characteristicsofanoligopolisticmarket.
- Whydooligopoliesgenerallyexhibitpricerigidity?Explaintheshapeofthekinkeddemandcurve.
- Name2waysfirmsinoligopolycancompetewitheachotherapartfromprice.
- Whataresomewayswhichfirmsinoligopolycancollude?
- Thinkof1advantageand1disadvantageunderoligopoly.