Even More Oligopoly

Price Rigidity  Price rigidity is a tendency not to change prices.  Price rigidity is a feature of many oligopolies.  Why?

Price Rigidity  Barriers to entry are high, so new firms find it difficult to enter the market and sell at a price lower than the existing equilibrium.  Oligopolists tend to prefer non-price competition to price competition.  Collusion, whether overt or tacit, is a feature of oligopoly which leads to price rigidity.  The existence of the kinked demand curve in some oligopolies persuades oligopolists to keep prices steady.

Non-price competition  Oligopolists are reluctant to reduce price, but instead compete on service, design, packaging, appearance and special offers.

ch?v=cfNzZre-sIU  Observe the non-price competition in this clip.

The kinked demand curve  Either an increase or a decrease in price will lead to a fall in total revenue (and most probably profit).

Kinked Demand Curve

To collude or compete  Collusion: collective agreements between producers to restrict competition.

The following firms provide…?  3UK  Virgin  Vodafone  O2  T-Mobile  Orange

 If 3UK increases their price, they will lose customers to the others that did not incease their price.  If they reduce their price, the others will also match their price reduction. They will win very few new customers. Therefore, it seems sensible for 3UK to neither increase nor decrease their price.

 Overt collusion (formal collusion) when firms make agreements openly among themselves to restrict competition, typically by reducing output or raising prices.  Tacit collusion:when firms collude without any formal agreement being reached or even without explicit communication between the firms.

 Barclays hit for LIBOR fixing  Barclays have been fined for distorting interest rates including the London Interbank Offer Rate. Barclays will pay $453m for using underhand tactics, including price-fixing, to rig the markets

 Price fixing in South Korea  Samsung Electronics and LG Electronics have been fined for conspiring to fix the prices of some appliances. The regulator said the two firms held secret meetings in 2008 and 2009 to agree on prices for washing machines, flat-panel TVs and laptop computers and has fined Samsung 25.8bn won, while LG was fined 18.8bn won

 In order to remove uncertainty in an oligopoly firms engage in collusive behaviour. When this happens the existing businesses decide to engage in price fixing agreements or cartels. The aim of this is to maximize joint profits and act as if the market was a pure monopoly.

Collusion……  Clearest example is fixing prices. However, it can also occur by fixing output  bidding for government contracts  even in decisions about marketing.

 CONTROLLING SUPPLY IN A CARTEL  For the cartel to work effectively the producers must control supply to maintain an artificially high price. Collusion is easier to achieve when there is a relatively small number of firms in the market and a large number of customers, market demand is not too variable and the individual firm's output can be easily monitored by the cartel organisation.

 PRICE AND OUTPUT UNDER A DUOPOLY  If two firms share the market equally and have the same cost structures, then each firm will profit maximise at output Q and each gain the same level of super-normal profit. Consider the case of Firm A in the diagram below. The firm is assumed to have half the total market demand. It can profit maximise and still achieve economic profit. The other firm in the market will also profit maximise at the same point and earn the same total profits. In the absence of a change in demand (which may not go equally to each firm) and/or a change in each firm's costs of production, neither firm has any incentive to undercut the other.

WHY DO PRICE FIXING ARRANGEMENTS OFTEN COLLAPSE?  Falling demand creates tension between firms e.g. during an economic downturn  The entry of non-cartel firms into the industry increases market supply and puts downward pressure on the cartel price

WHY DO PRICE FIXING ARRANGEMENTS OFTEN COLLAPSE?  Exposure of illegal price fixing by the Government or other regulatory agencies causes an arrangement to end  Over-production and excess supply by cartel members breaks the price fixing  The fact that the whistleblowing firm escapes without a penalty offers an attractive incentive to discontinue collusion.

Prisoners’ Dilemma  A game where, given the fact that neither player knows the strategy of the other player – the optimum strategy for each player leads to a worse situation than if they had known the strategy of the other player.

Game Theory  The analysis of situations in which players are interdependent.

The Prisoners’ Dilemma  Confess or not confess

Game Theory Pricing