Market Structure - Imperfect Competition II

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Oligopoly — a market with a small number of large firms whose actions affect each other.

Key features:

• Strategic interdependence — each firm's price/output affects rivals' decisions.
• High barriers to entry (capital requirements, brand loyalty, patents, economies of scale).
• Differentiated or homogeneous products possible.
• Examples: smartphones (Apple, Samsung, Google), aviation (Boeing, Airbus), oil majors, soft drinks (Coca-Cola, Pepsi).

Competing models:

Kinked demand curve — explains price rigidity. Firms believe:

• If they RAISE price, rivals WON'T follow → lose market share → demand elastic above current P.
• If they LOWER price, rivals WILL follow → no gain in share → demand inelastic below current P.
• Net: demand curve KINKED at current price; firms reluctant to change price.

Game theory and the prisoner's dilemma. Firms choose between cooperation (collude to raise prices) and defection (cut price for market share).

• Both cooperating = high industry profit.
• Both defecting = competitive outcome, low profit for both.
• One cooperates, one defects = defector gains a lot, cooperator loses.
• Each firm's DOMINANT strategy = defect → both end up worse off than if they'd cooperated.

Collusion — formal (cartel, like OPEC) or tacit (implicit understanding). Illegal in most countries because it raises prices and reduces consumer welfare.

Oligopoly outcomes:

• High prices, restricted output.
• Non-price competition (advertising, R&D, product differentiation).
• Risk of collusion.

Monopoly — a SINGLE firm dominates the market.

Causes (barriers to entry):

• Legal barriers — patents, copyrights, licences.
• Natural monopoly — production technology (high fixed cost; LR average cost falls as output rises). Examples: rail networks, water utilities.
• Economies of scale — incumbents have cost advantages.
• Control of essential resources — De Beers historically with diamond mines.
• Network effects — value depends on number of users (search engines, social media).

Monopoly outcomes:

• Profit-max at MR = MC.
• P > MC → allocative inefficiency.
• Possible X-inefficiency (slack management) due to no competitive pressure.
• Potential for price discrimination (charge different prices to different consumers).
• Long-run supernormal profit.

Pros of monopoly:

• Economies of scale lower costs.
• Profits can fund R&D and innovation (Schumpeter's argument).
• Natural monopolies avoid duplication waste.

Policy responses:

• Antitrust law — prevent mergers that reduce competition; break up monopolies (e.g. AT&T 1984, Standard Oil 1911).
• Regulation — price caps, quality standards, especially for natural monopolies.
• Public ownership — government runs the monopoly (e.g. national rail, water).
• Promote competition — reduce barriers, allow new entrants.