Economics: Pricing and Oligopolistic Market Essay

Submitted By Nhan2501
Words: 1964
Pages: 8

a. An oligopoly is defined as a market structure, which has a few producers dominate. Since the market is shared between few firms, oligopoly is described as a highly concentrated market. Even though there is few producers within the market, due to low barriers of entry, small firms are still able to enter the market. Examples of the oligopolistic market are the detergent market, which is dominated by Unilever and Procter & Gamble, or key companies in fast-food market are McDonalds and Burger Kings with 44% and 21.9% sequentially.
Oligopoly are divided into two types containing perfect oligopoly - refers to firms that sell uniform or homogenous goods and services, and imperfect oligopoly - oligopolists sell goods and services that are differentiated. Oligopolistic market structure is renowned for the conducts of firms in the market. There are many behavioral tendencies in an oligopolistic industry including interdependence, uncertainty, rigid price, non-price competition, mergers and collusion. However, the most noted behavior are interdependent decision-making and their uncertainty.
Each firm in oligopoly market keeps an eye on the activities taken by its rivals in the industry such as changes in prices, quantity and quality of output or changes in form of non-price competition. Since oligopolistic firms engage in competition among the few, the decisions made by one firm may directly affect to the operation of the others. To be more aware of interdependence and uncertainty behavior, we can utilize Game Theory or Prisoner's Dilemma to illustrate the concept. This is called a game because it's basically a two-move game, firms can either charge high prices or low prices and the decisions to set price will depend a lot on what the competitors will do. For example, 2 main dominances in the burger market are McDonalds and Burger Kings. £15 m

£15 m £30 m

£5 m £5 m

£30 m £ 10m

£10 m

The table above is called a payoff matrix, which shows the various payoffs based on the price decided by 2 price leaders under oligopolistic market. In the table is the level of economic profits that Burger Kings and McDonalds enjoy based on their decisions whether they will charge high (£7) or low (£5) prices for their meal. If McDonalds charge £7, Burger Kings should charge £5 at it will increase their profits from £15 m to £30m. However, if McDonalds lowers its prices to £5, Burger Kings should also take the same action by decreasing meal's prices to £5. Even though the profits will fall due to a drop in prices but instead of loosing £10m, by lowering prices down to £5m, Burger Kings will only loose £5m. The outcome will be that the £5 is a dominant pricing strategy that Burger Kings as well as McDonalds should charge and the economic profits of both firms will be equal to £10m. This can indicate that without the ability to collude or cooperate with one another and the certainty of what the rivals will carry out, McDonalds and Burger Kings will always end up at charging lower price for their products and earn a lower profit level. Therefore, the firms under oligopoly are interdependent in making decision as any changes in prices, products by an individual firm will have a direct influence on the fortune of its competitors. Thus, in oligopolistic market, decision-making process of a firm does not only rely on what the firm itself will do but also the reaction of its competitors. There are other games that companies can play besides those dealing with prices including whether to advertise or not, whether to offer discount or not, etc.
In fact, however, businesses will endeavor to collude or cooperate in a groups of companies from the same market to avoid price war and in some cases, maximize their share in the market or increase level of profits, such as Sainsbury's, Tesco and ASDA. The so-called behavior is named as cartel - a group of firms working together or colluding, even though this behavior