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2. (a) State and explain THREE key features of an oligopolistic market - Leaving Cert Economics - Question 2 - 2006
Question 2
2. (a) State and explain THREE key features of an oligopolistic market. (b) With the aid of ONE clearly labelled diagram: (i) Explain the shape of the 'kinked dema... show full transcript
Worked Solution & Example Answer:2. (a) State and explain THREE key features of an oligopolistic market - Leaving Cert Economics - Question 2 - 2006
Step 1
State and explain THREE key features of an oligopolistic market.
Answer
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Few Large Firms: Oligopolistic markets are characterized by a small number of firms that dominate the market. This status gives them significant market power, enabling them to influence prices and output levels. Examples include industries like telecommunications or automobile manufacturing.
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Interdependence: Firms in an oligopoly are interdependent; the actions of one firm will significantly affect the others. This can lead to strategic behavior like price setting or output decisions being made with the consideration of competitors’ actions.
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Product Differentiation: In many oligopolistic markets, firms offer products that are either similar or differentiated from one another, allowing for a competitive edge. This differentiation can relate to brand, quality, or features, leading to customer loyalty.
Step 2
With the aid of ONE clearly labelled diagram: (i) Explain the shape of the 'kinked demand curve' under oligopoly.
Answer
The kinked demand curve has a distinct shape resembling a kink or bend. The upper segment is relatively elastic because if a firm raises its price, others are likely to keep theirs stable, leading to a significant loss of market share for the firm that increases prices. Conversely, the lower segment of the kink reflects inelasticity; if a firm lowers its price, rivals will match the reduction to maintain market share, resulting in minimal gain to the price-reducing firm. This situation creates a 'kink' in the demand curve at the prevailing market price, suggesting that prices tend to be stable even in response to changes in costs.
Step 3
(ii) Explain the long run equilibrium position of a firm facing a 'kinked demand curve'.
Answer
In the long-run equilibrium, a firm faces a kinked demand curve which is conditioned by the actions of its competitors. The equilibrium price is established where marginal cost (MC) meets the demand curve. Due to the kink, any increase in marginal cost will not lead to a price increase as firms are reluctant to raise prices, thus the firm operates at the kinked equilibrium point. Therefore, firms can maintain their output without changing prices significantly, remaining stable in the long run unless there is a significant shift in overall costs.
Step 4
(iii) Explain what is meant by the term 'rigidity of prices' under a 'kinked demand curve'.
Answer
'Rigidity of prices' refers to the tendency of prices in an oligopolistic market to remain stable despite fluctuations in costs or demand. This occurs because firms are hesitant to change prices due to the kinked demand curve structure; raising prices can lead to a loss of customers, while lowering prices prompts rival firms to match the price cut. As a result, firms prefer to absorb changes in cost rather than alter prices, leading to a general stability in the pricing structure.
Step 5
Explain THREE types of collusion which may occur in an oligopolistic market.
Answer
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Price Fixing: Firms may agree to set prices at a certain level to avoid competition and maximize profits. This agreement can be explicit or tacit, and leads to higher prices for consumers.
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Market Sharing: Oligopolistic firms may divide the market amongst themselves to control areas of operation. By doing so, they reduce competition and can stabilize their sales and profits.
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Output Restrictions: Firms may agree to limit production to maintain higher prices. By collectively restricting supply, they can drive prices up, ensuring all firms in the collusion benefit from increased revenue.
Step 6
(ii) Do you believe that the Irish retail market for banking services (e.g. personal current accounts) operates under oligopolistic conditions? Explain your answer.
Answer
Yes, the Irish retail banking sector exhibits characteristics of an oligopolistic market. A limited number of banks dominate the market, leading to interdependence in pricing and services offered. Moreover, these banks often engage in product differentiation through various account features, fees, and customer service. While there is competition, price rigidity is observed, and behavior often aligns with a kinked demand curve, reflecting the uncertainty of actions among the few key players. Overall, the competitive landscape is tightly controlled, revealing oligopolistic traits.