Economic Management #7: Ogliopolies

[samvara]

Ogliopoly: a market dominated by a few large firms engaged in imperfect competition. Each member is likely to be aware of the actions of the others and will be influenced by their decisions. How we model this depends on what we assume about how rivals will set pricing and output.

• Rivals may collude (set prices and/or output) or practice non-cooperation (price wars)
• Rivals may have perfect knowledge of market or uncertainty

Characteristics of an ogliopolistic market

• size of the market
• number and concentration of firms (e.g. in Australia four banks dominate - Four pillars policy stops them merging. Other highly concentrated industries include mobile telephones, paper, cigarettes, batteries, cars, breweries, aeroplanes and oil)
• degree of interdependence
• type of products (while type differs, all products are highly substitutable so firms are interdependent)
  • homogeneous e.g. oil or steel industry
  • differentiated e.g. car or cereal industry
• significance of barriers to entry
  • economies of scale e.g. existing firms already have infrastructure to make things as cheaply as possible
  • high cost of entry e.g. production set up costs, promotion (competing with established brands), differentiating product
• mergers: created by
  • horizontal integration e.g. one firms merges with another with the same product
  • vertical integration e.g. one firm merges with one higher or lower on the chain of production
  • conglomerate integration e.g. firms in different industries merge to form one large company

Examples: Just because you dominate the market doesn't mean you'll stay that way.

1. In 1985 Motorola had 45% market share with Nokia on 22%. by 2005 Nokia held 35% and Motorola 15%. Nokia now challenged by Dell, Palm, NEC, Panasonic and Apple.
2. QANTAS market share gradually being eroded by Virgin in Australia

Three models of ogliopoly

• Cartels are where a group of firms agree to coordinate production and pricing to maximise profit. These are illegal in Australia.
  • firms behave like a single monopolist and profits are distributed to each cartel member
  • firms with homogeneous goods are more likely to form cartels (e.g. OPEC)
  • price is determined by...
• Price Leadership (a form of tacit collusion) where are dominant firm whose price for the good is sold by the rest of the industry. A price leader establishes the market price and other firms use that price and avoid competition. This keeps the price relatively high, maintains profits and deters smaller firms from getting into price wars. This works best when the firms are selling quite similar products (less differentiated)
  • e.g. Bunnings sets the price and all other hardware firms follow suit or get undercut (price war).
  • This can violate government competition laws and their is no guarantee that firms will follow the leader in which case the 'leader' must roll back prices or lose sales.
  • Amazingly complex diagram of cost curves indicating that Leader sets price, Followers sell at price and dominant firm (leader) soaks up market demand not met by followers.
• Game Theory (interaction between and strategic behaviour of similar size firms)