<2.11.5 OLIGOPOLY>

• THE CONCENTRATION RATIO (CR) refers to a measure of the CUMULATIVE MARKET SHARE of the LARGEST NTH FIRMS in the industry

  • • • • For example, CR3, refers to the total market share of the top 3 largest firms in the industry, whereas CR2, refers to the total market share of the top 2 largest firms in the industry.

        • A HIGH CR3 implies that a greater amount of market share is held by just a few firms, hence the industry is less competitive.

        • A LOW CR3 implies that a small amount of market share is held by just a few firms, hence the industry is likely to be more competitive.

• Products produced by oligopolistic firms are in most cases differentiated such as in the pharmaceuticals, cars, aircraft, breakfast cereals, and cigarettes market to name but a few, however, they can at times also be homogeneous products such as oil, steel, aluminium, copper, cement etc... though factors such location, after-sales service all help differentiate them from each other

• INTERDEPENDENCE refers to how the actions of one firm affect other firms directly in the industry. 

• In MONOPOLISTIC industries interdependence also exists, as a hawker stand could lower its price and take customers from another hawker stand selling similar products, similarly if one of the hawkers was to raise its price then those others which didn't, will take some of that firm's customers. However, if both firms decided to raise prices what would happen? Would they be able to exploit the customer and make more profits? The answer is no, as the LOW BARRIERS to entry would mean new entrants would come in and undercut them.

• HOWEVER in OLIGOPOLISTIC markets, the large firms have created HIGH BARRIERS to entry, which means they are able to prevent other firms from entering the industry, each firm's pricing behavior follows that of monopolistic firms except for when they both raise prices together, as in this market structure they will NOT face the threat of being undercut by a new entrant, however this practice of fixing prices higher is ILLEGAL in most countries.

RAISE PRICE => RIVALS DON'T => LOST SALES TO RIVAL

LOWER PRICE => RIVALS ALSO LOWER PRICES => PRICE WAR

PRICES TEND TO STAY RIGID

--MODEL ANSWER--

The international school market in Singapore exhibits the main features of an oligopoly. Firstly, there are a small number of large firms that dominate the market such as UWC, OFS, and SAIS, Secondly, there are very-high entry barriers, which include not only the large start-up costs and legal barriers but also the strong brand images and reputations of the schools, especially the oldest and most-established ones. Thirdly the service provided in terms of diploma is identical, however, the delivery of the course is highly differentiated, in terms of location, style, facilities, etc... which gives them slight market power. Finally, we can say that the market is highly interdependent as the actions of one school in terms of pricing will likely impact the demand for the other. For example, if OFS lowered its price it may take students from the other schools so the other schools would likely follow and also lower their prices leading to a 'price war', however, if OFS were to raise its price the other schools would be unlikely to follow and would take students from OFS as a result. However, if all schools were to raise prices together, then due to the very high barrier to entry they would not be undercut and could make demand more inelastic and possibly make more by acting as a monopoly. However, as this is an illegal practice in Singapore, we find that the schools do not compete on price, but rather by using non-price methods such as branding, facilities, location, exam results etc...

• Apply the CHARACTERISTICS OF OLIGOPOLY LISTED ABOVE to the market for INTERNATIONAL SCHOOLS IN SINGAPORE

• As mentioned above, one of the key features of this market structure is 'INTERDEPENDENCE' which COMPELS FIRMS TO TAKE INTO ACCOUNT THE ACTIONS OF THEIR RIVALS.

• Therefore all future planning regarding pricing and production decisions must incorporate an element of strategy, and hence we call this type of decision-making 'STRATEGIC-BEHAVIOUR' 

• WRITE A PARAGRAPH:

• Imagine you are going to enter a writing competition with a prize of $1000, and you learn that there are only 2 entrants. 

• Clearly, you need to think strategically about the actions of your competitor, as their output will ultimately impact your outcome, if they write a better essay they will take all the prize money, but if you write a better one you will take the prize.

• So what would you decide to do? Is collusion an option?

Note: In your answer explain how you have conflicting objectives and justify your thought process.

If I were to enter a writing competition with a prize of $1000 and only two entrants, I would definitely feel the pressure to come up with an exceptional essay. However, the fact that there are only two entrants also raises the possibility of collusion, where the competitors could agree to split the prize money. This is a tempting option, but it raises ethical concerns about fairness and honesty. Ultimately, my conflicting objectives would be to win the prize money while also upholding my personal values and integrity. Thus, I would focus on crafting the best essay possible and competing fairly, while also being open to the possibility of negotiation with my competitor. Ultimately, I believe that competing fairly is the right thing to do, and winning the prize money without integrity would feel hollow and unsatisfying.

• GAME THEORY refers to a MATHEMATICAL TECHNIQUE analysing the behavior of decision-makers who are dependent on each other, and who use STRATEGIC BEHAVIOUR as they try to ANTICIPATE/GUESS THE BEHAVIOUR OF THEIR RIVALS. 

• One such game based on the behavior of interdependent decision-makers who use strategic behavior is the 'PRISONER'S DILEMMA' 

• This is a game showing how TWO RATIONAL, SELF-INTERESTED INTERDEPENDENT DECISION MAKERS TRY TO MAKE THEMSELVES AS WELL OFF AS POSSIBLE BY USING STRATEGIC BEHAVIOUR, BUT ACTUALLY END UP BECOMING WORSE OFF, contrary to Adam Smith's conclusion that by pursuing one's own interest, society will eventually benefit.

• This situation involves TWO prisoners A and B.

• In this scenario both desire the shortest sentence possible which occurs in box 4 with a total of 2 years.

• They know that if they both 'Don't testify' they will get 1 year each.

• However, if one testifies while the other doesn't, they will go free, while the other will get 8 years.

• They also know that if they both testify they will get 3 years.

• With the chance of the other not testifying and going-free and out of fear that the other will be INCENTIVISED OUT OF SELF-INTEREST to seek the go-free option like them and end up with 8 years, they both testify and end up with 3 years each.

• So. BY SEEKING SELF INTEREST, THEY BOTH LOSE OUT on the best outcome.

• Another way of looking at this is by assuming that each individual will choose their DOMINANT STRATEGY. We can see that for each prisoner, testifying will either give 3 years or zero years for a total of 3, whereas not testifying will give either 1 year or 8 years for a total of 9. 

• Therefore, the worst-case scenario of testifying is a maximum of 3yrs, while the worst-case scenario of not testifying is 8yrs, hence, given the imperfect information between the two, they will choose the least worst-case scenario which is 'to testify'.

• Use the above examples to create your own payoff matrix dilemma for display using the google slide provided in GOOGLE CLASSROOM.

• Create a slideshow like the ones above. The slideshow will be printed on A4 by me and displayed outside.

• Use Chat GPT to generate a list of scenarios in which the prisoner's dilemma can be illustrated, you can add context by adding 'sports scenarios' or 'school scenarios'. 

• Make sure you add your own payoff values in your prompt and ask for a 'payoff matrix' or the ChatGPT answer won't make sense.

• Remember the goal is to show that acting out of self-interest does not yield the optimal outcome.

• A COLLUSIVE OLIGOPOLY refers to a situation in which an agreement between firms is made either formally or informally to limit competition,  increase monopoly power and increase profits. The most common form of collusion involves...

  • • • Holding prices constant at some level,...  

      • Raising prices by some fixed amount,... 

      • Withholding supply, in order to raise prices,...

      • fixing price differences between different products,... etc

      • Collusion is ILLEGAL in most countries, because it works to limit competition, raise prices, and lower output.

FORMAL COLLUSION usually comes in the form of a 'CARTEL' which is an open agreement between firms in an industry to take actions to LIMIT COMPETITION in order to INCREASE PROFITS. 

The agreement may involve 

• Limiting and fixing the quantity to be produced by each

• Fixing the price at which output can be sold; 

• Setting restrictions on non-price competition (such as advertising); 

• Dividing the market according to geographical or other factors; 

• Agreeing to set up barriers to entry. 

Whatever the case, the objective is to limit competition, increase the monopoly power of the firms, and increase profits. 

• FIRMS FACE DIFFERENT DEMAND CURVES: 

  • • • We have previously learned that THE MORE DIFFERENTIATED A PRODUCT IS, THE MORE INLELASTIC THE PRODUCTS DEMAND IS. 

      • Members of OPEC, produce identical products, which makes charging a single price much easier as their demand curves have always been very elastic and so accepting a single price change should have an equal impact on Qd. 

      • If however products are differentiated then they face downward-sloping demand curves with different elasticity values. This means that if the firms were to agree to raise prices, some would have INELASTIC RESPONSES AND MAKE MORE TR while others would have ELASTIC RESPONSES AND LOSE TR.

• THE INCENTIVE TO CHEAT: Every firm in a cartel faces an incentive to cheat on the agreement, by offering to secretly lower the price for some buyers, or else offer other concessions. 

• NUMBER OF FIRMS: The larger the number of firms, the more difficult it is to arrive at an agreement regarding price and the allocation of output, as the greater number of differing views make an agreement and compromise more difficult to achieve.

• RECESSIONS: During recessions (periods of low or falling incomes and low levels of economic activity) sales fall and profits are reduced; at such times firms have a stronger incentive to lower prices and cheat on the agreement, endangering the survival of the cartel.

• POTENTIAL OF NEW ENTRANTS: If a cartel is successful, it will make large economic profits, encouraging entry of new firms into the industry. If there are new entrants, increased industry supply will drive price down cutting into the cartel’s profits. The cartel’s long-run survival therefore depends on high barriers to entry that block potential new entrants.

• NO DOMINANT FIRM TO START WITH: The presence of a dominant firm facilitates reaching an agreement, as this firm can assume a leadership position in the negotiations leading to the agreement. For example, in the case of OPEC, the dominant member of the cartel is Saudi Arabia, which is also the largest producer of oil among all the members. The lack of a dominant firm makes agreement among the cartel members more difficult to reach.

• Imagine that the international schools in Singapore wished to create a cartel. Explain using the 7 REASONS mentioned above why this would be difficult to establish and/or maintain.

• TACIT COLLUSION (or INFORMAL COLLUSION) refers to co-operation that is implicit or understood between the co-operating firms, WITHOUT A FORMAL AGREEMENT. 

• One type of informal collusion is PRICE LEADERSHIP, where a DOMINANT FIRM IN THE INDUSTRY (which may be the largest, or the one with lowest costs) SETS A PRICE THAT ALL OTHER FIRMS WILL FOLLOW. 

Imagine there are three firms, A, B, and C. Say that firm A considers a price change, but before changing (increasing or decreasing) its price, it tries to predict how firms B and C will react, and what will be the consequences of their reaction. Firm A’s reasoning is as follows:

• IF I RAISE MY PRICE, what will B and C do? They are unlikely to increase their price, because if they continue to sell at the original price, many of my customers will leave me and start buying from B and C. Therefore, B’s and C’s market share will increase, and mine will fall. I should therefore not increase my price. 

• IF I DROP MY PRICE, what will B and C do? They are likely to drop their price as well, because if they do not, I will capture a large portion of their sales, and I will be better off at their expense. But if they drop their price, I won't capture any of their market share, and will only pick up some new customers now that my price is lower or my existing customers will buy a few more. I should therefore not drop my price.

• I should therefore not change my price, and should continue selling at original price.

Using the concept of PED, use a diagram to illustrate the impact If OFS decides to lower its prices and/or raise its prices. (10) 

OLD PAPER 1:

--10-MARKERS--

• Explain why prices tend to be relatively rigid in oligopolistic markets

• Explain why firms might wish to collude.

• Explain why firms in oligopolistic markets may prefer to use non-price competition.

--15-MARKERS--

• Oligopolists often possess too much monopoly power. Evaluate whether governments should intervene in oligopolistic markets. 

• Discuss whether producers in oligopolistic markets should compete or collude. 

• Discuss the reasons why firms compete or collude in oligopolistic markets.

• Discuss whether an oligopolistic firm should collude rather than compete

In the payoff grid, we can see that both firms' profits depend on the actions of their rival. If we look at the situation from Firm B's perspective we can see that for Firm B if they were to maintain their prices and Firm A did the same they would both earn $18m, however, if Firm A was to lower its price and undercut Firm B, then they would only earn $3m, while Firm A would take all the extra business and earn $24m whereas if they both lowered their prices together they would earn $8m each. 

Similar to the prisoner's dilemma above, the firms will choose the better of the two worst-case scenarios. From Firm B's perspective, the worst-case scenario of cutting the price, will be profits of $8m, while the worst-case scenario of maintaining the price is profits of $3m, hence they will choose to cut prices. This is exactly the same strategic thinking of Firm A.

• Watch the video below, complete the decision matrix and then explain how the situation will likely result in both being worse off.

• This situation involves TWO GUYS A and B.

• 3 girls, one referred to as 'THE BLONDE' and the other two as 'THE FRIENDS'

• In this scenario, both desire the blonde.

• They know that the best outcome is to agree to both ignore the blonde and they are guaranteed to get 1 friend each.

• However, the first one to approach the blonde will get her, while the other has to settle for one of the friends and watch his smug mate date the blonde. 

• Out of fear that the other will seek the blonde option, and to avoid the potential of seeing their smug face, they will both rush to the blonde at the same time, and being polite she will refuse both, and her friends will also say no, now that they feel second best. 

• So. by seeking self-interest, they both lose out on the best outcome.

• Another way of looking at this is by assuming that each individual will choose their DOMINANT STRATEGY. We can see that from each boy's perspective, going for the blonde will either give them the blonde or no one, whereas not going for the blonde will give either the blonde's friend or the loss of the blonde to your smug mate. Therefore, the worst-case scenario of going for the blonde is going home alone, while the worst-case scenario of going for the blonde's friend is losing the blonde to your smug mate, hence, you will choose the least worst-case scenario which is 'to go for the blonde.