Oligopoly

Game theory

Oligopoly

Market failure

Market failure exists when the competitive outcome of markets is not efficient from the point of view of the economy as a whole. This is usually because the benefits that the market confers on individuals or firms carrying out a particular activity diverge from the benefits to society as a whole.

Good transport links bring clear economic benefits, but the UK still has a long way to go before its transport system is fit for purpose. As the Labour party gathered in Manchester, political hot potatoes such as High Speed 2, the proposed ‘northern corridor’ link between Manchester and Leeds and the problem of increasing airport capacity were under debate.
For Mary Creagh, shadow transport secretary, too little has been done to create a transport system which puts the passenger first. She bemoaned the tendancy of Whitehall clerks to think of transport as a series of “modes”.

“I walk, cycle and get the tube to get to Westminster. This needs to be looked at from the user’s perspective,” she said. For some of Creagh’s constituents living on Wakefield’s estate, it’s cheaper for a family to use a taxi together than to pay for the bus. “This is market failure,” she said.

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Oligopoly - evaluating costs and benefits of collusion

Competition Policy in Markets and Industries

The main aims of competition policy are to promote competition; make markets work better and contribute towards improved efficiency in individual markets and enhanced competitiveness of UK businesses within the European Union (EU) single market.

Competition policy aims to ensure

• Technological innovation which promotes dynamic efficiency in different markets
• Effective price competition between suppliers
• Safeguard and promote the interests of consumers through increased choice and lower price levels

There are four key pillars of competition policy in the UK and in the European Union

1. Antitrust & cartels: This involves the elimination of agreements that restrict competition including price-fixing and other abuses by firms who hold a dominant market position (defined as having a market share in excess of forty per cent)
2. Market liberalisation: Liberalisation involves introducing competition in previously monopolistic sectors such as energy supply, retail banking, postal services, mobile telecommunications and air transport
3. State aid control: Competition policy analyses state aid measures such as airline subsidies to ensure that such measures do not distort the level of competition in the Single Market
4. Merger control: This involves the investigation of mergers and take-overs between firms (e.g. a merger between two large groups which would result in their dominating the market)

Main Roles of the Regulators

• Regulators are the rule-enforcers and they are appointed by the government to oversee how a market works and the outcomes that result for producers and consumers

• The main competition regulator in the UK is the Competition and Markets Authority (CMA)

• The European Union Competition Commission is also an important body for the UK

Examples of competition policy in action

• De-regulation - laws to reduce monopoly power
  • Preventing mergers/acquisitions that create a monopoly
  • Laws to introduce competition into the postal services industry
  • Forced sales of assets e.g. BAA and airports in the UK
• Privatisation - transferring ownership
  • Stock market floatation of the Royal Mail
  • Part-privatisation of Network Rail similar to the sell-off of HS1 - the high-speed link that connects London's St Pancras to the Channel tunnel, on a long-term concession
• Tough laws on anti-competitive behaviour
  • Strong laws and penalties against proven cases of price fixing or collusion that involves market sharing
  • Companies breaching EU and UK competition rules risk hefty fines of up to 10 per cent of global turnover - senior executives can be jailed
• Reductions in import controls
  • A reduction in import tariffs encourages cheaper products from overseas
  • Increasing or eliminating import quotas can also have the same effect
  • Allowing new countries into the European Union single market increases contestability

Source: Tutor2u

Oligopoly - Concentration Ratios

Concentration ratio

A concentration ratio is the ratio of the combined market shares of a given number of firms to the whole market size. It is commonest to consider the 3-firm, 4-firm or 5-firm concentration ratio. Concentration ratios are used to assess the extent to which a given market is oligopolistic. Although there is no definitive 'rule' about what ratio constitutes an oligopoly, a 4-firm concentration ratio of over 60% would indicate a highly oligopolistic market.

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Market concentration measures the extent to which sales in a market are dominated by one or more businesses

What is market concentration and how is it measured?

• The concentration ratio measures the combined market share of the top 'n' firms in the industry.
• Share can be by sales, employment or any other relevant indicator.
• The value of 'n' is often five, but may be three or any other small number. If the top 'n' firms gain a high market share the industry is said to have become more highly concentrated.

The Herfindahl-Hirschman Index (HHI)
This is a measure of market concentration. The index is calculated by squaring the % market share of each firm in the market and summing these numbers.
For example in a market consisting of only four firms with shares of 30%, 30%, 20% and 20% the Herfindahl Index would be 2600 (900 + 900+ 400+ 400).

• The index can be as high as 10,000 if the market is a pure monopoly (100*)
• The lower the index the more competitive the market is and can reach almost zero for perfect competition
• If an industry has 1000 companies each with 0.1% market share then the index would only be 10 (1000 x 0.1*).

A recent merger guidelines note in the UK suggested that a market with a HHI measure exceeding 2,000 can be characterised as 'highly concentrated.
For example, if a local radio station market consisted of two companies with 40 per cent each, and of two companies with 10 per cent each, it would have an HHI of 3,400
The superior quality and accuracy of the Herfindahl Index over the simple concentration ratio can be seen when three markets are examined each with a four firm concentration ratio of 85%.
Assume that in each market the remaining 15% of the market is controlled by 15 firms each with 1% market share.

• Market A: 40% 20% 20% 5% = 85% - Herfindahl Index = 2440
• Market B: 25% 20% 20% 20% = 85% - Herfindahl Index =1840
• Market C: 75% 5% 3% 2% = 85% Herfindahl Index = 5678