The Possibilities And Effects Of Raising Prices Above Competitive Levels In Oligopolistic Markets - Assignment Example

? OUTLINE AND EXPLAIN THE POSSIBILITIES AND EFFECTS OF RAISING PRICES ABOVE COMPETITIVE LEVELS IN OLIGOPOLISTIC MARKETS? Course Date Introduction Oligopoly is a general economic method in the current society. The term “oligopoly” originates from the Greek “oligos” connoting "little or small” and “polein” implying “to sell.” When “oligos” is utilized in the plural, it means “few.” Therefore, Oligopoly is a condition in which a particular market is run by a small group of firms. In such a market, a general deficiency in competition can result into higher costs for clients (Cassimatis 1996). Since the sellers are few, each oligopolist is always keen on the actions of the competitors. The resolutions of one firm manipulate and are prejudiced by the resolutions of other (Blinder & Baumol 2004). Oligopoly is the middle ground between monopoly and capitalism. He describes an oligopoly as a small group of businesses, two or more, that control the market for a certain product or service (Samuelson & Marks 2002). This gives these businesses huge influence over price and other aspects of the market. Examples of oligopoly in our economic system today include Steel industry, Aluminum, Film, Television, Cell phone and Gas among others (Perloff 2011). The probability of raising prices above the competitive levels demand a detailed understanding of the oligopolistic markets and the influential trends involved. Normally, the possibilities prevalence depends on the desire of the involved firms for success. In this piece, the mention of the possibilities would imply the probability of occurrence of raised prices above the competitive levels. In this situation, when such an issue is mentioned, many would tend to begin asking themselves on whether the probabilities are activity prompt or automatic. Again the choices by the firms in the market that attribute to alteration of the prices beyond the competitive levels have consequences. Moreover, the essential point to understand in this scenario is the essence of prices, their thresholds and the effect of status in the oligopolistic market (Mansfield 1982). Oligopolistic markets have variant features relating to the prices such as the limited number of firms selling the same commodities. If there are a number of firms dealing on similar products then it implies that there must be a significant extent of competition for which the price is a critical factor. Altering the price in a particular firm would impact the entire market since one of the market forces is altered. The provision of branding of products by different firms means that the products are distinct and each might be identical to the associated firm. The entry barriers might possess a negligible concern albeit they are considered imperative due to their significant influence and regulation in the number of firms (McGuigan, Moyer & Harris 1999). Firms in the oligopolistic market cooperate to determine prices and endeavour to uphold the price levels. The prices are regarded as monopolistic since they are the main point of concern in the market. The firms compete on the prices min order for the prices to remain as a competitive industry model. In the situation where firms compete on prices, the desired price is regarded as the competitive level price. This implies that evident consequences can result if any firm elevates its prices beyond the actual one determined by the competition in the market (Cassimatis 1996). The monopoly as well as the competitive scale is responsible for the determination of price and the benefits involved in the market. Oligopolistic market prices and the consequential profits are indefinite since the challenges in modeling inter-reliant price productivity deliberations (Glahe & Lee 1982). Background Investigation Having looked at the oligopolistic markets, what are would be the possibilities and effects of raising prices above competitive levels? In order to have an in-depth understanding of the preceding question, we have to understand the characteristics of oligopolistic markets. Industries that form part of an oligopoly share a number of widespread distinctiveness They are less concentrated than in a monopoly, but more concentrated than in a competitive system (Nicholson 2006) There exists competition inside an oligopoly, case in example is the airlines. Airlines equal competitor’s air fares when using same itineraries. The case applies to the automobile companies which in the fall when the new-fangled models are released. As soon as one decreases the financing rates the others will follow suit.    The businesses offer an identical product or services. This creates a high amount of interdependence which encourages competition in non price-related areas, like advertising and packaging. The tobacco companies, soft drink companies, and airlines are examples of an imperfect oligopoly (Blinder & Baumol 2004). An oligopolistic market is characterized by high barriers to entry. This situation differentiates oligopoly from perfect competition and monopolistic competition which have no barriers to entry (Blinder & Baumol 2004). Each company’s equilibrium tactic decides its price as a determinant of its own privately-observed payoff limit. The privately observed differences in payoff-function limits effectively enable companies to adopt a deterministic pricing strategy that appears random to their competitors (Cassimatis 1996). Collusions But oligopolistic rivalry can result in an array of outcomes. For instance, in a bid to raise market prices, the companies may decide to use restrictive trade practices such as collusion and market sharing. There are different types of collusion (Blinder & Baumol 2004). Overt collusion happens where the key players formalize their agreements such as when firms form trade associations like the Association of Petrol Retailers. Covert collusion happens when firms try to bury the outcomes of their collusion, in a bid to circumvent discovery by regulators, such as when fixing price. Tacit collusion comes into play when firms act together, referred to as acting in concert, but where there exists no official or unofficial agreement. For instance, the firms may agree that a particular firm becomes the pacesetter in terms of setting prices, and other companies will basically follow the lead of this firm. All firms always have this ‘understanding’, but no accord or evidence exists to prove it. If companies do collude, and such collusion is verified that it has resulted in reduced competition, such firms are prone to be subject to regulation. Therefore, in most instances, tacit collusion is complex or next impossible to (Ferguson & Ferguson 2002). But from the onset, all collusions are aimed at raising prices and limiting production, just as the instance in a monopoly. Where there exists an official agreement for such collusion, it is referred to as a cartel. A chief illustration of such a cartel is OPEC which has intense control on the international price of oil (Mansfield 1982). Under this arrangement, firms are at will to raise market prices above competitive levels. This is one perfect instance where the players in an oligopolistic market can raise prices above competitive levels. The one danger for such a strategy is that it may give room to entry by other competitors who may beat the barriers to entry and offer lower prices (Cassimatis 1996). Market Division Schemes Another key factor and determinant whether firms can raise prices above competitive levels is the market division schemes. These schemes are accords in which competitors partition the market amid themselves as provided in the advantages and disadvantages of an integrated market (Mansfield 1982). Such schemes entail firms allocating different consumers, product lines, or geographical regions among themselves. For instance, one firm might be granted the right to be the single seller in some geographical regions in exchange for its not selling—or quoting only very high prices—to buyers in other regions controlled by other members of the conspiracy (Kamien & Schwartz 1975). The biggest danger to the market division scheme is that a new player, non-partisan to the agreements may enter the field and venture into one of the quotas bearing high market prices and in turn reduce their prices. This will result into direct loses by the firm that had raised their prices above the competitive levels. If the new firm can overcome the barriers to entry and venture into the over-priced market, it would still make profits since they will be selling their products at the competitive market price (Ferguson & Ferguson 2002). Bid Rigging In other instances, sellers compete for a sale by presenting bids. This is always the case when private firms sell huge quantities of goods or services or incredibly expensive products to local, state, and federal governments. For example, the Veterans Administration VA), which runs many major hospitals, buys aspirin in big quantities. They look for bids from aspirin suppliers and buy from the companies that tender the aspirin at the lowest cost (Samuelson & Marks 2002). In such scenarios, companies can raise their profits through rigging the bidding procedure. For example, assuming there are three aspirin suppliers and that VA buys aspirin three times a year. If the three firms competitively bid in each of the three bidding process, the VA might get a very good price as the firms all try to undercut their rivals. But suppose these three firms collude. They might decide that they will each win one of the bids (Samuelson & Marks 2002). For instance, firm A might be assigned to win the first bid. They know that the other two firms will be submitting high bids. Firm A knows that they can win the contract with what ordinarily would have been a high price. Then, in the other two contract bidding processes firm A knows that is it suppose to submit very high prices and that the other two firms will be permitted to win each of the other two contracts. All firms earn more profit by rigging the bidding then if they competed strongly for each of the contracts. Companies are extremely ingenious in how they have rigged bidding processes in order not to be caught (Nicholson 2006). There are a number of risks in using bid rigging to raise prices above competitive levels. A new player in the market is likely to win consequent bids due to lower competitive prices. This will in-turn force the ones rigging bids to lower their prices in order to remain competitive. Unfortunately, in most instances, by the time their prices are lowered, they would have lost a good number of clients (Mansfield 1982). Another big risk for the above methods is that the tricks detailed above—are more often than not illegal. Firms apprehended engaging in such activities face the possibility of costly fines and/or jail time. Nonetheless, at times firms engaging in such collusion are not caught and they earn the higher profits that collusion can bring. Successful collusion can result into high profits. But collusions have proved to be very delicate. There are disparities over what prices to put in place, total industry production, and over market shares of accomplice firms. Into the bargain, cheating by firms – tendering clandestine low prices to a number of buyers – is rewarded highly. Consequently, firms could try to engage part in more rivalry in order to benefit at the outlay of other firms. This is likely to provoke other firms – if the other firms find out this cheating – to also raise their competitive attack.. This can result into a very aggressive environment for firms. Also, in other oligopoly markets, collusion exists for some time, which is then followed by a phase of competition. After some time, nonetheless, the companies once again attain a collusive outcome (Ferguson & Ferguson 2002). Market Power Market power provides us with another possibility where a firm may raise prices above competitive levels. Market power is the capability of a company to gainfully increase the market price of a good or service in excess of marginal cost. In perfectly competitive markets, market players do not have market power. A company having total market power has the capacity to increase prices devoid of losing any customers to (Kamien & Schwartz 1975). Markets players with market power are consequently at times known as price makers, whereas those lacking are known as price takers. Considerable market power is when prices surpass marginal cost and long run average cost, therefore the company realizes economic profits (Mansfield 1982). The principal companies in an oligopolistic market time and again have big factories, massive advertising budgets, patented products, and control over raw materials. These barriers to entry make it almost impossible for new players to contend with them.   Bearing in mind that oligopolies are protected from competition, they are therefore in a position to exercise market power and raise their prices above what they would be in a more competitive market.  However, companies must exercise caution.  Since there exist other manufacturers in the field, a firm that increases its price excessively may lose some of its customers to competitors (Mansfield 1982).  Of course, a company can increase prices and retain a good number of its clients if all the other companies in the market also increase their prices.  It is for this reason that there exists such a strong appeal for firms to collude, or agree not to compete.  Just as stated previously here-in above, collusion is illegal in most countries and corporations that are proven guilty of colluding are fined and their management at times sent to jail (Kamien & Schwartz 1975).   Conclusion Whether or not they collude, oligopolies regularly earn considerable economic profits.  This is not always the outcome of insightful management; protected as they stand from the severe challenges of competition, even mismanaged oligopolies have the capacity to realize excellent profits.  Due to this fact, it remains a question to numerous economists if oligopolies are as careful about reducing costs as the case with competitive firms.   Another bother to economists is that oligopolies are inept at assigning resources.  Market power facilitates oligopolies to set prices that are well over their marginal costs of production.  This translates to the fact that meaningful deals are not being realized in such markets, those that would profit both parties.  Nothing angers economists more than seeing an opening to make a meaningful deal go unexploited (Nicholson 2006).   It is difficult to establish, in theory, whether oligopoly firms will—or will not—be competent. This can only be established through probing each oligopoly industries. Some oligopoly firms have proved to be competent; other oligopoly firms are proved to be inefficient. Some oligopoly industries make reasonably high profits. This means therefore that they have, the capital needed to attain production efficiency and dynamic efficiency. Again, most oligopoly firms have established methods to generally circumvent extensive rivalry. Such firms have miniature incentive to devote to strategies that might lead to productive efficiency or dynamic efficiency (Mansfield 1982). Some oligopoly firms actually encounter irregular severe rivalry from within the market industry. At times the degree of rivalry within an oligopoly can be exceptionally high. It is an empirical issue therefore as to whether a particular oligopoly industry can raise price levels above competitive standards and still (Kamien & Schwartz 1975). 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