A2: ESSAY Unit 3 - ECON 3 JAN 10 [06] DATA RESPONSE 2 (25 marks): Oligopoly colluding

Here I have attached my essay answer for this question; it is graded an A. Remember a good essay needs a balance of knowledge, application, analysis, and evaluation. My essay isn't perfect but I hope you can benefit from it nevertheless. After the introduction, I have included a paragraph explaining why oligopolies can mistaken for colluding due to nature price rigidity in oligopolistic markets  *please do not repost without credit, thanks!

 

‘When oligopolists collude, the results can be anti-competitive and against the consumer interest’ (Extract E, lines 27-28) Evaluate policies that could be used to deal with this problem (25 marks)

Oligopoly is where a market is dominated by a few firms holding majority of the market share thus a high level of market concentration. However behaviour such as use of product branding, barriers to entry, interdependency etc. promotes anti-competitiveness which is most significant in identifying oligopolists. There are several policies that can be used to tackle problems of collusion (which can act against consumer’s interests) such as interventions from the government for example; subsidising new competitors and taxation.

As illustrated in diagram 1, price rigidity is a common characteristic of oligopolies. Firms will not charge above ‘P’ due to elastic demand thus a rise in price will lead to a more than proportionate decrease in demand, furthermore firms will not charge below ‘P’ due inelastic demand thus a decrease in price will lead to a less that proportionate increase in demand hence prices being very stable. Additionally the discontinued or vertical section of the MR curve highlights that if costs increase (MC1 to MC2), marginal cost will still equal to marginal revenue thus price and quantity will remain unchanged and vice-versa thus price rigidity. However this raises concern for the government as behaviour of collusion such as price-fixing is illegal within the UK and EU; thus government may be concerned by oligopoly behaviours [Extract E, lines 3-5] highlights that anti-competitive behaviour will be put down. Thus if collusion practices among oligopolies were proven deliberate, the government will have to take action.

 
 

Firstly government may subsidies new competing firms’ thus promoting competition and diluting market power of original oligopolists. Assuming the oligopolies are operating at the minimum efficient scale (MES) therefore at productive capacity as illustrated in diagram 2, new firms entering the market (at ‘Pn’ / ‘Qn’) will have difficulty competing with existing oligopolies that benefit from low costs due to economies of scale. The government can therefore subsidies cost for the new competitors (‘Pn’ to ‘Psubsidy’) thus allowing new firms a more stable position to of compete against the existing oligopolies and therefore deals with anti-competitiveness of an oligopoly market. In addition subsidising new competitors will reduce unemployment and will therefore promote growth. However there are several problems with this policy.

 

A fundamental part of oligopolies is that they rely non-price competition; for example brand loyalty. New firms are unable to compete with large brand names for example in the motor vehicle industry; Volkswagen, Fiat, BMW etc. therefore it is still difficult for new firms to compete despite subsidies from the government. Furthermore oligopolists depend on huge research economies of scale for product differentiation thus efficiency is a major component; even with subsidies new firms are only operating at ‘Psubsidy’ whereas existing oligopolies are operating at ‘Po’  (productive efficiency). Moreover this suggests that existing oligopolies can exercise predatory with their low costs and price thus forcing new competitors into bankruptcy.  Therefore new competitors are still unable to overcome several barriers to entry despite government subsidies thus intervention maybe considered unnecessary and a waste of government spending and therefore can be considered as government failure. In addition [Extract E, lines 30-31] states that ‘the industry will find it difficult to support many firms’ thus subsidising new competitors into the market may also damage the motor vehicle industry greatly.

 

 

However it is assumed that the existing oligopoly is operating at the lowest point of the average cost curve therefore experiencing MES. [Extract E, table] suggests for the motor vehicle industry to reach MES, firms require 20% of the market; however as illustrated in [extract D] the closest to 20% is Volkswagen with 18.3% of the market share thus no firm is operating at MES. Therefore in reality government subsidies may allow new competitors a strong position in the market.

 

 

Another policy the government can execute is by imposing taxes on the industry’s raw material suppliers e.g. steel industry as the demand for steel is a derived demand from the motor vehicles; thus indirectly forcing the motor vehicle manufacturers to pay more for the materials and with their rigid pricing may therefore weaken their barriers to entry. For example taxation will decrease oligopolists’ profits which may reduce their advertising budget and thus promotes competition as it enables other competing firms more of a chance to compete with a reduction in advertising. Additionally it will also reduce the use of limit pricing of oligopolists if their costs increase as they are no longer able to exploit low prices from lower costs. Furthermore fewer profits will mean oligopolists will have less to spend on research and development therefore reduces the chances of product differentiation thus products will become more homogenous which will promote more competition in the industry.  However such policy will also act against the interest on consumers. For example is research and development expenditure decreases firms may not be able to experience dynamic efficiency and will lose out on international competition (highlighted in [extract D] Japanese companies already own 13.8% of the EU market share of the motor vehicle industry) and thus consumers will have to pay higher prices compared to that outside the UK and EU, furthermore there will be a reduction of consumer choice. Additionally taxing their raw material suppliers will be unfair for them as they have to suffer higher prices and to accommodate this, for example the steel industry may need to decrease their costs by laying off workers thus promoting unemployment. Thus such policy may not be the most effective to deal with the problem of collusion and non-competitive behaviour. 

 

 

Overall in conclusion there are several policies that can deal with oligopolies colluding, by subsidising new competitors thus promoting more competition into the market however this does not handle with many high barriers to entry set by oligopolies thus it may be still very difficult for new firms to compete with existing oligopolies thus intervention of subsidies may be considered government failure. Another policy is taxation to reduce oligopolists profits and therefore reduce the power of their barriers to entry. However this will result in several problems for the oligopolist such as lack of profits to spend on research and development thus increasing costs which will be passed on to consumers and lack international competitive strength. Therefore it may be a combination of policies is required to tackle the problem of collusion and anti-competitiveness such as use of legislation as well as taxes and subsidies etc. However it could be argued that market mechanism is self-sufficient and operates best alone thus no intervention is needed; additionally there may be no collusion between oligpolists and it is just oligopolistic nature to have stable prices which may seem to look like price-fixing thus no intervention or policies may be required at all.