Explain why prices tend to be stable in oligopolistic markets. An oligopoly is a market structure in which a few large firms, each with a high degree of market share dominate the industry. Price stability exists in oligopolistic markets either because firms collude and fix prices to eliminate competition, or due to the kinked demand curve of the noncollusive oligopoly. Firms in oligopolistic markets mostly tend to be mutually interdependent. This means that due to the small number of firms present, decisions taken by one firm affect the other firms in the industry, hence they depend on one another. If one firm changes its behaviour, the others follow suit. Firms are keenly aware of the actions of their rivals. A noncollusive oligopoly exists where firms in the industry act strategically by competing independently, taking into account the possible actions of rival firms. The kinked demand curve model explains the price stability, as firms do not fix or coordinate prices. As can be seen in the diagram, oligopolistic firms are profit maximising, as shown by the shaded area. Firms produce at Q1 and sell at P1. Due to the assumptions of mutual interdependence, and asymmetric information, there is a kink in the demand curve. If there are three firms in a market and one of them considers a price change, before changing its price, it will analyse and predict as to how the other two firms will react. If the firm decides to increase its price, the other firms will continue to sell at P1, not following that firm. Instead more customers will choose to buy from the firms with the lower price. And hence the firm that increases the price will lose market share. This is because the demand curve beyond point P1 is relatively elastic. This suggests that even a small increase in price will decrease the quantity sold, hence prices are rarely increased. On the other hand, if one firm decides to decrease the price, other firms will follow suit. They will also decrease their prices because, if not, the firm with the lowest price will get the market share of the other two firms, making the others worse off. However, if all firms reduce prices, the demand curve below P1 is inelastic, implying that even a large price decrease will only result in a small increase in quantity sold. Therefore, it is beneficial for all firms to keep prices stable.
Collusive oligopolies also have stable prices because, the few large firms dominating the market, come together and fix prices, formally or informally. This allows all the firms to benefit, as they’re able to charge high prices and become profitmaximisers, at the same time produce less and eliminate all forms of competition. An example of an oligopolistic market is Singapore’s taxi industry. Six large firms dominate the market. The prices tend to be very stable as most firms charge similar fare prices. Any price changes initiated by the market leader, all other firms tend to follow suit. This is also visible in the smartphone industry, where firms like Apple and Samsung charge similar prices for their smartphones. Oligopolists often possess too much monopoly power. Evaluate whether governments should intervene in oligopolistic markets. Oligopolies have a few large firms which dominate the industry. Often times oligopolies possess monopoly power which is when all firms come together, that is they collude, hence behaving like one large firm. When firms engage in anticompetitive behaviour, governments should intervene, as this could harm third parties such as consumers. Mainly a collusive oligopoly is one that behaves like a monopoly. When firms come together and fix prices, they eliminate competition. Once competition is eliminated all firms can enjoy high profits, making them all profit maximisers. Quotas on quantities each firm sells is also set. As can be seen from the diagram, to maximise profits, firms will sell at the point where MC = MR, which is Qpm and charge the price Ppm. As can be seen, the quantity is lesser than market equilibrium and price is higher than equilibrium. Average costs are low, hence profit can be earned, as shown in the shaded area. The profits are equally shared amongst colluding firms, and quantity is split amongst firms. In the case of collusion, governments must intervene. Firstly, when oligopolists are behaving as monopolies, consumers are the first ones to be exploited. Consumers lose out the most because they end up having to bear high prices,
especially if there are no substitutes. Furthermore, consumer surplus declines greatly. It rather becomes part of the producer surplus. This creates inequality and disparity in the distribution of income. In addition, when firms behave like monopolies, they become allocatively and productively inefficient. In pursuit of higher profits, firm charge higher prices and restrict output. Also they lack incentive to produce at the lowest point of AC. Also due to high barriers of entry, it is very difficult for new firms to enter the markets. Hence, it is crucial for governments to take action in order to prevent exploitation. When firms exploit market power and act against public interest, governments through policies can break monopoly power. For example a government can stop the merger of two large firms, if the merge will not be beneficial for the public. Also, in most countries governments have made the formation of cartels illegal, so any form of collusion that occurs is merely secretive. Furthermore, governments can introduce price controls, by setting maximum prices. This is to prevent firms from charging high prices to consumers. In addition, governments often choose to support smaller firms, for example by giving them grants and subsidies. However, there are drawbacks of the government intervening in the markets. Firstly monopoly powers, since are profit maximisers, have access to large amounts of financial resources. They are able to invest in research and development projects, and they are able to generate new ideas and products. Furthermore, oligopolistic firms tend to enjoy huge economies of scale as they operate on a large scale. In conclusion, it depends on each industry.
Explain how business spending on research and development and government expenditure on infrastructure might shift the longrun aggregate supply curve. Aggregate supply is the amount of real national output that firms are willing and able to produce at each price level. According to the new classical model, the long run aggregate supply is vertical at the full employment level of output. the LRAS is independent of the price level, as this represents the maximum level of national output of the economy per time period. The quantity and quality of natural resources (factors of production) affect the LRAS. Research and development is when firms spend in improving their products or services. Or when investments are made to improve technology as means of increasing productive capacity. Infrastructure are essential services such as roads, buildings, power supplies etc that are important for increasing efficiency of economic activity. These are provided by the government. Investing in R&D and infrastructure are crucial to a country’s economy. They foster economic growth. The improvement in the quantity and quality of the factors of production increases the productive capacity of the economy. Sustainable economic growth only occurs when there is a shift in the LRAS curve. As can be seen in the diagram, a shift in the LRAS curve suggests that economic growth has been achieved. This growth is sustainable as the economy is now capable of producing more output than before. Firms spend on research and development and this improves the quality of physical capital such as machineries. Long term investments in developing new technologies improve work processes and enhance efficiency, increasing the productive capacity. With more faster and efficient technology firms are able to produce larger quantities of output, which results in the shift of the LRAS. For example, R&D have allowed for the automation in the car industry, vastly improving the production of cars. Wireless technologies have allowed communication and operations to improve at the workplace. Innovation have led to the development of products such as smartphones and tablets. Large firms like Apple and Samsung spend enormous amounts in R&D to improve their products and the technologies they use.
In addition, infrastructure is the basic support system of the economy and hence governments invest in improving the quality as to increase efficiency of the system. Investment is a key component of aggregate demand as well, and hence an increase in AD will boost economic growth in the short run. Investments in the long run will shift the LRAS curve to the right and attract foreign direct investment, helping the economy to flourish even more. Governments spend on improving transportation systems, from roads to railway stations, telecommunications, electricity grids and sewage systems, all as means of fostering economic growth. Evaluate the effectiveness of interventionist supplyside policies to achieve economic growth. Supply side policies are government strategies aimed at boosting the productive capacity of the economy by increasing the quality and quantity of factors of production. By improving the FOP’s long term economic growth can be achieved, with a shift in the LRAS curve as shown in the diagram. Interventionist policies are deliberate attempts by the government to deal with market imperfections in the economy. They focus on four areas: investment in human capital, investment in technology, investment in infrastructure and industrial policies. Human capital refers to the knowledge, skills and expertise of the workforce. An important part of the interventionist policy has been to increase human capital and spend on education and training to raise the skills, mobility and productivity of the labour force. Education has a positive externality and several benefits. It increases the employability of the workforce. Less individuals remain unemployed and hence it also increases the size of the workforce. Training is beneficial as the labour acquires more skills and hence productivity goes up, increase the quantity of output produced. Furthermore, improved communication can reduce frictional unemployment in the economy. While better health of the workers decreases absenteeism and improves productivity. The increase in AD in short and run and shift in the LRAS suggests that human capital improves the productive capacity of the economy and is vital for the growth and development.
Long term investments in developing new technologies, through R&D improve work processes and enhance efficiency, increasing the productive capacity. With more faster and efficient technology firms are able to produce larger quantities of output, which results in the shift of the LRAS. Infrastructure is the basic support system of the economy and hence governments invest in improving the quality as to increase efficiency of the system. Industrial policies are those that target specific key industries to promote economic growth. For example tax allowances can be used to protect domestic infant industries from larger foreign rivals. Tax cuts are targeted at strategic industries to help revive them. A combination of tax breaks and subsidies on commercial loans can create incentives for firms to locate in the less prosperous area, which helps to reduce unemployment and foster long term economic growth. There are hence several benefits of governments using interventionist policies to foster economic growth. Supply side policies are much more effective in promoting growth than demand side policies. This is because, they aim on achieving long term economic growth, which comes from an increase in productive capacity and a shift of the LRAS curve. Demand side policies foster only short run growth as they merely go beyond productive capacity and return to the LRAS curve later on. Supply side policies also help keep inflation levels low. An increase in the productive potential of the economy helps to prevent the rising of general price levels beyond control. Unemployment also remains low, because when the government spends in strengthening human capital, the workforce becomes much more efficient and productive. This increases national output in the long run as the labour force is more employable. In addition, when national output increase, it can help a country improve its balance of payments. When there is investment in technology, human capital and infrastructure, output increases, making exports more competitive. However, there are also several drawbacks of supply side policies, especially interventionist policies. There are problems that can occur with government intervention. The intervening of governments may lead to inefficiencies and misallocation of resources. Also it relies heavily on government spending and this is especially a problem with incompetent and corrupt governments, hence that way market based policies are perhaps more efficient. The biggest drawback of supply side policies is the time lag. The time supply side policies take to reap the benefits is very long. E.G it could take an entire decade for a nation to enjoy the benefits of improved education and training, infrastructure etc. Also, it is criticized that inversitionist supply side policies do not necessarily improve equity in the distribution of income, rather the economic growth can create more disparities in income distribution. In conclusion, I believe the advantages of interventionist supply side policies outweigh its drawbacks. Countries with noncorrupt governments can benefit hugely from these policies, as this is the most effective way to achieve long term economic growth. Singapore is one example of a nation that has benefited immensely. The government aims to achieve economic growth through use of interventionist supply side policies and has been effective.
