oligopoly-price-and-non-price-competition

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Competition in Oligopoly Markets

Firms in an oligopolistic market are highly competitive and can use price or non-price strategies to increase market share
There is a high degree of interdependence between competitors in an oligopoly market
- Competitors closely watch each others actions
- They are very responsive to new innovations
- They use game theory to determine the best course of action

Non-price competition tends to be the most common way in which they compete
- The focus of competition is on product differentiation to develop brand loyalty
  - E.g. Firms achieve this high levels of spending on advertising, branding, packaging, loyalty cards, etc

Price competition is less common, as firms want to avoid a price war
- As goods and services are very close substitutes in an oligopolistic market, a price change initiated by one firm will cause other firms to react to price change
- Individual firms will take into account the likely reactions of their competitors
  - This mutual interdependence leads to price stability or rigidity within the market
- The kinked demand curve demonstrates the concept of price rigidity

The kinked demand curve provides one explanation of why prices are stable in oligopolistic competition
Rival firms react to price changes initiated by a competitor

If a firm increases its price from P to P₁, it is unlikely that rival firms will follow the price increase
- The firm will lose consumers to rival firms if they charge a higher price
This means that a small increase in price leads to a greater than proportionate decrease in quantity demanded, resulting in an overall fall in market share and total revenue
- This section of the demand curve is elastic

If a firm decreases its price from P to P₂, it is likely that rival firms will respond by also decreasing price
- All firms in the market will offer the new lower price
- Market share remains the same. However, total revenue and profit decline for all
This means that a decrease in price leads to a less than proportionate increase in quantity demanded, resulting in an overall fall in total revenue
- This section of the demand curve is inelastic

The change in elasticities, brings about a kink in the demand curve at a price level of P
- This creates price rigidity, as firms tend not to change price due to the anticipated behaviour of competitors (mutual interdependence)
To avoid a price war, firms focus on non-price competition strategies to increase sales
- This is why there is a high level of expenditure on research and advertising in oligopolistic industries

Reasons why Oligopolistic Firms Engage in Non-price Competition

Reason	Explanation
Operation of cartels	If a small number of firms form a cartel, they agree a fixed price for their product This is anti-competitive and illegal. If they are caught, these firms are subject to high fines Some of the most famous cartels include the Middle East Oil Cartel (OPEC) and the drug cartels in Mexico and Columbia
Price leadership	A dominant firm in the industry is usually the price leader. Other smaller firms typically set a price close to it E.g Coca-Cola acts as the dominant firm, and its rival PepsiCo adjusts prices close to it. They differentiate through advertising campaigns or highlighting unique flavours
Price agreements	Firms may engage in price fixing to keep prices high E.g In the airline industry, major airlines might agree to set high ticket prices. To compensate for lack of price competition, they may focus instead on improving customer service or loyalty programmes
Price wars	This occurs when competitors repeatedly lower prices to undercut each other in an attempt to gain or increase market share By focusing on non-price strategies such as product differentiation or branding, firms can reduce the risk of engaging in price wars
Barriers to entry	Firms develop their advertising and branding as it increases barriers to entry New firms then find it difficult to compete with goods that have established brand loyalty with consumers

Evaluating an Oligopoly Market Structure

Advantages	Disadvantages
Consumers may benefit with lower prices. With a few firms dominating the market, large-scale operations result in economies of scale, reducing average costs Lower costs enable firms to generate supernormal profits, which can be reinvested in research and development to create more innovative goods/services for consumers A high degree of competition gives firms an incentive to continuously strive to improve the quality of goods and services	High barriers to entry restrict the number of firms entering the market Fewer firms may result in less innovation of goods and services The dominance of a few firms enables control over prices or output. Limited competition results in fewer choices for consumers High levels of spending on branding and advertising can increase production costs. This cost may be passed on to consumers through higher prices There is a potential for firms to engage in illegal collusion or operate as cartels by fixing price or output

Advantages

Disadvantages

Consumers may benefit with lower prices. With a few firms dominating the market, large-scale operations result in economies of scale, reducing average costs
Lower costs enable firms to generate supernormal profits, which can be reinvested in research and development to create more innovative goods/services for consumers
A high degree of competition gives firms an incentive to continuously strive to improve the quality of goods and services

High barriers to entry restrict the number of firms entering the market
- Fewer firms may result in less innovation of goods and services
The dominance of a few firms enables control over prices or output. Limited competition results in fewer choices for consumers
High levels of spending on branding and advertising can increase production costs. This cost may be passed on to consumers through higher prices
There is a potential for firms to engage in illegal collusion or operate as cartels by fixing price or output