Explain, with relevant economic theories and with the use of diagrams, the factors affecting the price and output decisions of an oligopoly firm. [10]

An oligopolistic market refers to a market that is dominated by a few firms, each possessing a significant market share. What are the assumptions for an oligopoly? There are four assumptions for an oligopoly firm. There are few sellers and many buyers, high barriers to entry, imperfect information and either homogeneous or differentiated product. There is mutual interdependence or rivalry between firms in an oligopolistic market, which leads to strategic, game theoretic behaviour of firms. Mutual interdependence or rivalry refers to a situation where a firm has to consider the reactions of its competitors when making its decisions, in which it might make strategic, game theoretic pricing and output decisions. This economics essay thus attempts to explain how mutual interdependence or rivalry affects a firm’s price and output decisions, and how collusion and advertising affect a firm’s decisions.

Oligopolies tend to have sticky prices that are rigid and are often unchanged. In an oligopoly, when a firm lowers its price, it will draw a significant number of customers away from its rivals. These rival firms are unlikely to sit back and do nothing but will instead lower their prices in response to avoid losing a big portion of their sales.

However, should a firm raise its price, it will instead lose much of its customers to its rivals. Since its rivals benefit by not reacting they will probably not raise their price in response. Based on such observations, oligopoly pricing behavior based on the kinked demand curve was derived, showing price rigidity.

[Insert a diagram on oligopoly’s kinked demand curve model]

The oligopolistic firm will set the price at MC = MR. The firm will not produce at any output where MC > MR as they generate losses. Hence, the profit maximizing or the loss minimizing point is when MC = MR. This kinked demand curve model shows that there tends to be price rigidity in an oligopoly due to mutual interdependence. Firms tend to stick to the prevailing price and are reluctant to change to alter prices.

An oligopoly firm will only alter its price if its marginal costs change substantially, and if the marginal costs fall significantly there could be a price war - an oligopoly will decide rationally that it could lower prices, increase output, and thus put some rivals out of business.

[Insert a diagram on oligopoly’s kinked demand curve model - showing a price war]

There are other factors affecting the decision of price and output by oligopolistic firm. For instance, collusion may affect the oligopolistic market and help make it become a monopoly market.

Collusion refers to the act of firms jointly determining the price or output. There are two types of collusion, namely explicit collusion and tacit collusion. Collusion can be explicit where firms formally gather to fix prices or output. A formal collusion oligopoly is called a cartel. Tacit collusion could still occur as firms cooperate informally by following a price leader. Both explicit and tacit collusion can work like a monopoly market which can control output and set the price.

[Insert diagram on collusive oligopoly - monopoly diagram]

           

A collusion oligopoly can be a price setter as a monopoly at maximum profit point i.e. MC = MR and set the price without the limit of price rigidity of an oligopolistic firm.

When there is a price war, the oligopolistic firms retaliate by cutting prices, triggering successive rounds of price cuts. Such an occurrence is known as a price war, which is generally detrimental to all firms as heavy losses are incurred throughout the market. A firm might want to punish its rival for taking unilateral actions. In addition, the reasons for price wars are less strategic and more short-term in nature. For example, due to an unexpected recession, managers might desperately slash prices in order to make sales targets or to raise revenue to overcome cash flow problems.

In conclusion, the factors affect the price and output of a firm in an oligopolistic market is mainly price rigidity which depends on the market itself. Collusion oligopoly will give the firm more market power to set its price beyond the limitation of price rigidity. A price war may result in decreasing prices of the firm. Therefore, the price and output of a firm in an oligopolistic market are affected by many factors in different conditions.

JC Economics Essays - H2, H3 Economics essays - tutor's comments: This economics essay deals with oligopolies, strategic behaviour, and pricing and output decisions of firms, with a simple hint of game theory, assuming that firms are rational and thus make rational decisions. Game theory is an important mathematical tool that can help in general economics analysis, but specifically, especially for H3 examinations, undergraduate economics courses, and economics in general. However, there was very little depth of game theory in this economics paper. There are many important elements of this economics essay which make it worth many marks and a rather good examination grade. However, the usual questions for improvement still apply: how could you make this essay answer better? Could examples have been used? Always try to answer the question, and think of how you could make your answers better when dealing with economics questions. 

"Monopolies exist mainly because monopoly firms create barriers to entry by manipulating their prices to keep potential competitors from contesting their markets." Do you agree with this argument? [15]

"Monopolies exist mainly because monopoly firms create barriers to entry by manipulating their prices to keep potential competitors from contesting their markets." Do you agree with this argument? [15]

In this essay, the thesis presented would be artificial barriers being used by firms as indicated by ‘create’. As manipulating prices was given as the method to keep potential competitors from entering their markets, the specific arguments would be limit pricing and predatory pricing as the artificial barriers. On the flip-side, the anti-thesis would be artificial barriers created by government and natural barriers already present. Hence, this essay seeks to first explain how limit pricing and predatory pricing are being used by firms before going on to explain some artificial barriers created by the government such as licenses and patents as well as some natural barriers such as reaping substantial economies of scale and a natural monopoly. The essay would then conclude by evaluating which kind of barriers is more effective in keeping potential competitors from entering a monopoly’s market. 

Firstly, limit pricing is where the monopoly sets the price of its goods lower than the average cost of that of a potential entrant. This would greatly deter the potential entrant from wanting to enter the market as he would lose out by being unable to earn any profits unlike the monopoly. As such, it is evident how a monopoly can utilize limit pricing as a mean to keep potential competitors from entering the market.

Secondly, predatory pricing is whereby the monopoly sets the price of its goods lower than the average cost of that existing competitor in the market. This would enable the monopoly to successfully remove his competitor from the market since the competitor would start to make losses and become unable to survive in the market. This would in turn deter potential competitors from entering the market as they would not want to end up in the same situation as that competitor which was defeated, showing how predatory pricing is effective in keeping new competitors from entering. 

Besides manipulating prices by firms, the government can also keep potential competitors from entering the monopolies’ market through issuing of licenses and patents. Licenses and patents from the government give the monopolies the legal authority and right to produce their goods which are therefore even more differentiated and new firms are prevented from entering by law. This illustrates how the government, and not the firms themselves, can create artificial barriers to disallow potential competitors from entering the market. 

On the other hand, natural barriers also exist. Large firms like monopolies already existing in the market reap substantial economies of scale. This keeps potential competitors out of the market as the start-up costs are very high and it is thus very hard for them to survive in the industry, thus deterring them from entering. 

Another natural barrier would be a natural monopoly which already has high barriers to entry to begin with, allowing it to keep potential competitors from entering the market. [NOTE: Economics tutor's comments on this short sentence: This is not really the case; it’s more of the fact that no two firms can exist in the market at the same time because of the falling LRAC throughout the entire range of demand.]

[Insert diagram of Natural monopoly]

In conclusion, artificial barriers are usually more effective than natural barriers in keeping potential competitors from entering the market of monopolies. This is due to the fact that monopolies are mostly run by governments who then can create artificial barriers on their own. At the same time, it is also within the control of the firms to create their own barriers, especially by manipulating prices, to keep their competitors out of the market. 

JC Economics Essays - standard 'A' level H2 Economics essay: Tutor's comments on the essay - Special thanks to A.G. for her contribution, as well as the econs students behind this very impressive work. Other than the section in which I had to explicitly correct the students' written work, this essay is still generally quite good. Why is this essay good, and what makes it worthy of a grade A? It addresses the question and generally gets to the point quickly. It identifies the theme and then does a very good job of trying to address the parts of the question that help to get good grades. Although the student did require me to address one section by writing in an explicit comment on the concept, the general idea was still there, and overall the paper was quite good, especially with the natural monopoly diagram. Think of how to draw the economics diagrams for all your essays properly, and be careful as to what they look like. All the best, and think of how you could do better. Thanks for reading and cheers!