This document discusses oligopolies, which are markets dominated by a few large firms. It covers key concepts like collusion, price leadership, and the prisoners' dilemma. It explains how oligopolistic firms are interdependent and face a kinked demand curve. This leads to price rigidity even when costs change. As price competition is limited, firms compete through non-price factors like innovation, branding, and promotions. Examples show concentration in industries like petrol, cinema, and mobile phones. Price wars can boost sales but hurt profits. Overall, economies of scale, mergers, and barriers to entry tend to increase market concentration over the long-run.

1. Economics of Oligopoly
Topic 3.3.9

2. Economics of Oligopoly
Topic 3.3.9
Students should be able to:
• Understand the characteristics of this market structure with
particular reference to the interdependence of firms
• Explain the behaviour of firms in this market structure
• Explain reasons for collusive and non-collusive behaviour
• Evaluate the reasons why firms may wish to pursue both
overt and tacit collusion

3. Key Concepts – Oligopoly
Cartel
Association of businesses or countries
that collude to influence production
levels and thus the market price
Collusion
Takes place when rival companies
cooperate for their mutual benefit
Kinked demand curve
Assumes that a business face a dual
demand curve for its product based on
the likely reactions of other firms
Price leadership
When one firm has a dominant position
and firms with lower market shares
follow the price changes of the leader
Prisoners’ dilemma
Problem in game theory that
demonstrates why two people might not
cooperate even if in their best interests

4. Basics of an Oligopoly
• An oligopoly is an imperfectly competitive
industry where there is a high level of market
concentration.
• Oligopoly is best defined by the actual conduct
(or behaviour) of firms within a market
• The concentration ratio measures the extent to
which a market or industry is dominated by a
few leading firms.
• A rule of thumb is that an oligopoly exists when
the top five firms in the market account for
more than 60% of total market sales.

5. Oligopoly in Action! UK Petrol Market
16.5%
14.4%
13.2%
10.9%
10.3%
10%
6.8%
5.8%
3.8%
2.3%
2.2%
1.5%
0.8%
0.7%
0.4%
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0%
Tesco
BP
Shell
Esso
Sainsbury's
Morrisons
Asda
Texaco
Certas Energy
Murco
Jet
Unbranded
Minor brands
Harvest Energy
Maxol
Market share, per cent

6. Oligopoly in Action! UK Cinema Market
25.5%
23.9%
22.2%
5.8%
3.8%
18.7%
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0%
Cineworld
Odeon
Vue
National Amusements
Empire Cinemas
Others
Cinema market share in 2013 (per cent)
Exhibitor

7. Global market share of the world's largest automakers in 2013
12.3%
12%
11.9%
9.3%
8.4%
7.8%
6.3%
5.3%
4.4%
3.2%
3.4%
2.8%
2.4%
2.4%
8%
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0%
Toyota
General Motors
Volkswagen
Hyundai-Kia
Renault-Nissan
Ford
SAIC Motor
Fiat-Chrysler
Honda
Suzuki
Peugeot
Daimler
BMW
Chang
Other
Market share
SAIC Motor Corporation
Limited is a Chinese state-
owned automotive
manufacturing company
headquartered in Shanghai,
China
Shares of the Global Car Industry in 2013

8. Market share of mobile handset manufacturers in the UK in June 2014
31.8%
22.9%
16.9%
6.7% 6.1%
3.7%
2.4% 2.1%
7.4%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
Samsung Apple Nokia Sony HTC RIM Motorola LG Other
MarketshareA Contestable Oligopoly

9. Revenue of dominant sports betting companies
2.5
2.18
1.82
1.07
0.74
0.73
0.48
0 0.5 1 1.5 2 2.5 3
William Hill
bet365
Ladbrokes
Paddy Power
bwin
betfair
Unibet
Revenue in billion U.S. dollars in 2014

10. Characteristics of an Oligopoly
Best defined by the actual behaviour of firms
A market dominated by a few large firms
High market concentration ratio
Each firm supplies branded products
Barriers to entry and exit
Interdependent strategic decisions by firms

11. Meaning of Strategic Interdependence
• Strategic interdependence means that one firm’s
output and price decisions are influenced by the
likely behaviour of competitors
• Because there are few sellers, each firm is likely to
be aware of the actions of the others.
• Decisions of one firm influence, and are influenced
by, the decisions of other firms
• This causes oligopolistic industries to be at high risk
of tacit or explicit collusion which can lead to
allegations of anti-competitive behaviour
• In oligopoly there is a high level of uncertainty

12. The Kinked Demand Curve
• A business in an oligopoly faces a downward
sloping demand curve but the price elasticity of
demand may depend on the likely reaction of rivals
to changes in one firm’s price and output
• (a) Rivals are assumed not to follow a price
increase by one firm, so the acting firm will lose
market share - therefore demand will be relatively
elastic and a rise in price will lead to less revenue
• (b) Rivals are assumed to be likely to match a price
fall by one firm to avoid a loss of market share. If
this happens demand will be more inelastic and a
fall in price will also lead to a fall in total revenue

13. The Kinked Demand Curve - Analysis
Price
and
Cost
Output
AR1
P1
AR2
• Theory starts with assumption that
firms are settled on a price P1 and
quantity Q1
• At price D1 the demand curve is
elastic above P1 and it is demand
inelastic below P1
Q1

14. Kinked Demand Curve – Raising Price
Price
and
Cost
Output
AR1
P1
AR2
• Raising price above P1: Likely reaction
of other firms is to hold their prices
• This will cause an elastic demand
response for this firm
• Results in lost sales and falling total
revenue
Q1
P2
Q2

15. Kinked Demand Curve – Cutting Price
Price
and
Cost
Output
AR1
P1
AR2
• Cutting price below P1 – the likely
reaction of other firms is to follow the
price reduction. Demand likely to be
relatively inelastic – little benefit in
terms of extra sales and total revenue
Q1
P2
Q2
P3
Q1

16. Kinked Demand Curve – The Kink!
Price
and
Cost
Output
AR1
P1
AR2
• If demand is relatively elastic following
a price rise and relatively inelastic after
a price fall – we create a kink in the
oligopolists demand curve (AR)
Q1
P2
Q2
P3
Q1

17. Kinked Demand Curve – The MR Curve
Price
and
Cost
Output
AR1
• The marginal revenue curve is always
twice as steep as average revenue
• There will be two marginal revenues
curves if AR is kinked
• We find a vertical intersection – at
quantity Q1 the two curves do not
actually intersect
MR1

18. Kinked Demand Curve – Equilibrium?
Price
and
Cost
Output
AR1
• Is there a profit maximising equilibrium
in this market? In the diagram here
MC1 cuts through the gap in the
marginal revenue curve
MR1
MC1
Kinked demand curve model assumes:
Other firms will follow if prices are cut
Firms will not follow if prices rise

19. Kinked Demand Curve – Price Rigidity
Price
and
Cost
Output
AR1
• One of the key predictions of the
kinked demand curve model is that
prices will be rigid or “sticky” even
when there is a change in the marginal
costs of supply (this is assuming that
firms in the market are profit seeking)
MR1

20. Kinked Demand Curve – Price Rigidity
Price
and
Cost
Output
AR1
• One of the key predictions of the
model is that prices will be “sticky”
even when there is a change in the
marginal costs of supply (assuming
that firms are profit seeking)
MR1
MC1
MC2
Kinked demand curve model assumes:
Other firms will follow if prices are cut
Firms will not follow if prices rise

21. Kinked Demand Curve – Overview
On oligopoly firms have price-setting
power but may be reluctant to use it
Rivals unlikely to match a price rise and
rivals likely to match a price fall
If a firm is settled on one price, there
may e little point in changing it
Even if costs change we often see price
rigidity / stability in an oligopoly
This increases the importance attached
to non-price competition

22. Examples of Non-Price Competition
Innovation
Quality of service
including after-sales
Free Upgrades to
Products
Exclusivity / Loyalty
Schemes
Branding Sales Promotions

23. UK advertisers ranked by spending
264.34
177.26
149.79
119.1
116.27
97.04
92.55
88.36
81.52
75.68
74.59
72.15
68.98
63.59
63.15
0 50 100 150 200 250 300
British Sky Broadcasting Ltd
Procter & Gamble Ltd
Bt Ltd
Unilever UK Ltd
Tesco Plc
Asda Stores Ltd
Talktalk Grp
Virgin Media
William Morrison Supermarkets Plc
Dfs Furniture Co Ltd
Vodafone Ltd
McDonalds Restrs Ltd
Reckitt Benckiser (UK) Ltd
Loreal Paris
Nestle
Expenditure in million £ in 2013

24. Real World Examples of Price Wars
Low cost
airlines
Supermarket
petrol
Mobile phone
tariffs
Price wars and impact on suppliers
Supermarket price war squeezes small supplier profit margins by a third
A report published in November 2015 found that small suppliers with an annual
turnover below £25m lack the negotiating power of big rivals and as a result,
their profit margins have fallen in one year from 3.5% to 2.1%. By contrast, at
the biggest food companies, whose turnover tops £1bn, margins increased from
5.2% to 5.4% last year

25. Who Wins and Loses from Price Wars?
Winners
•Regular
consumers
•Managers –
higher sales
Losers
•Shareholders -
lower profits
•Suppliers – may
get squeezed
Price wars may lead to short run increases in
sales and revenues, but may not be in the
long-term commercial interests of a business

26. Long Term Tendency towards Oligopoly
• Large minimum efficient scale (high ratio of fixed to
variable costs of production)
Economies of scale
• Consolidation of industries through acquisitions e.g.
horizontal integration between suppliers
Mergers and takeovers
• High rates of profits and barriers to entry & exit
Rise of dominant brands

27. Economics of Oligopoly
Topic 3.3.9