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Price Leadership Model
In this oligopoly market structure there is one dominant firm in the industry which, due to its size, sets the price within the industry and all other smaller firms follow suit.
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Sales Territories
Limit/Predatory Pricing
Firms agree to divide up the market and not compete in each others' territories
Types of Collusion
Existing large firms who benefit from economies of scale agree to lower their prices forcing new entrants out of business or forcefully taking them over.
This is a slide!
Collusion means rival firms working together to restrict prices/quantities. These sorts of activities are usually illegal and tend to last for only short periods of time due to trust issues.
Implicit Collusion
Owners vs managers
(Principal/agent problem)
Output Policy
Without direct communication the firms decide to not compete in terms of price at the risk of a price war. Instead they engage in non-price competition
Satisfactory Profit Levels (Work vs Leisure)
Firms agree to only produce a certain amount of output in the industry.
Limit/predatory pricing
Aims other than Profit Max
Avoiding Government Intervention
e.g. Windfall tax
Sales Maximisation
Profit
Baumol's Sales Max Model
Check A2 book
Catch 22
Quantity
I can:
Oligopoly Long Run Equilibrium
Price
MC
Criticism of this model......
Where did price come from????
P
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ATC
Supernormal profits are earned due to barriers to entry. AR>ATC
Price charged is P1 at this price Quantity Q1 is produced.
Equililbrium occurs at point E where MC=MR and MC cuts MR from below.
Costs are at E and can rise between X and Y without increasing the firms price.
Scarce resources are used efficiently as the firm is producing at the minimum point of ATC
The Kinked Demand Curve
X
----------------------------
This isn't where I parked my car
E
Y
Origin of Kinked Demand Curve
D=AR
Price
A
Q
Quantity
The Demand curve in oligopoly is made up of 2 distinct demand curves which cross where price is set.
The upper section (A-B) is the elastic section. If the firm decides to increase its price in this section none of its competitors will follow suit and thus there will be a large decrease in demand.
The lower section (B-D) is the inelastic section. If the firm decides to lower its price in this section all of its competitors will follow suit, this is known as a price war.
If the firm decides to make either of these decisions it won't increase its revenue, thus its best course of action is to do nothing.
This leads to price 'rigidity' in Oligopoly {A.K.A. Sticky Prices}
B
---------------
Price
MR
A price war is a period of fierce competition between rival firms. In which they undercut each others prices. It decreases both firm's revenue, thus they would prefer non-price competition.
The kinked demand curve is really 2 intersecting Demand curves. An inelastic one and an elastic one.
We only consider the relevant sections of each.
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P
---------------
DE
----------------------------
DI
D
Quantity
Q
Remember if each additional unit is sold for a lower price then Marginal Revenue is decreasing.
And if the marginal is lower than the average then the average is falling
The Discontinuous Marginal Revenue
Price
e.g. OPEC
Every downward sloping D=AR curve has a corresponding downward sloping MR curve beneath it.
As our D=AR curve is made up of 2 distinct sections there will be 2 distinct sections of the MR curve too.
Unusually however our MR curve has a discontinuous section: Point X to Point Y.
We already know that the price and quantity are fixed at the kink in the D curve. We also know that the firm will produce where MC=MR.
This means that the MC curve cuts the MR curve somewhere in the discontinuous section.
If MC changes within this region the firm doesn't change its price. If MC falls the firm makes additional profit, if MC rises the firm absorbs the additional cost. Prices remain constant unless there is a large change in cost forcing the MC curve out of this region i.e there is price constancy
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P
X
----------------------------
The firm doesn't automatically increase/decrease its price every time there is an increase/decrease in costs as this would create other costs e.g. constantly changing the price lists on menus/advertising materials.
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Y
D=AR
Quantity
Q
MR
Spectrum of Markets
Price
Perfect Competition Imperfect Competition Oligopoly Monopoly
Quantity