Competitive Oligopoly | A-Level Economics Model Paragraph
The Kinked Demand Curve
A competitive oligopoly market consists of a few firms; each firm is likely to have a similar market share, and barriers to entry and exit are likely to be high. As firms do not have significant monopoly power, they would not have as much price making power. The Kinked Demand curve below shows this.
The kinked demand curve shows the price and quantity in a competitive oligopoly. In this market, there are a few firms all competing with each other for market share, such as with coffee shops or supermarkets. The diagram shows that prices are 'sticky' at p1 and are unlikely to change. If firms tried to raise their prices, they would lose the majority of their demand because consumers would go to their cheaper rivals who are selling similar products. If firms tried to lower their price, other firms would also immediately lower their price as well so firms would only gain a small amount of market share by doing this. Therefore, firms keep prices the same.
Non-price competition
The impact of this is non-price competition. Firms know that they would struggle to gain market share even if they lowered their prices, so this encourages them to focus on non-price factors. Firms compete to have the best advertising, quality, customer service, special offers and create brand loyalty. This benefits customers as they can choose from coffee shops or supermarkets and choose the one which has their favourite branding, customer service and loyalty bonuses. For example, customers may choose Tesco because of the Clubcard or choose o2 because of the deals on the Priority app. Firms also benefit over time because of customer inertia; customers continue to buy from the same firms out of habit or convenience. Behavioural economics teaches us that humans aren't always rational decision makers, and they aren't able to quickly process information or make the best decisions. Overall, non-collusive behaviour leads to non-price competition, which consumers should benefit from.
Evaluation
In evaluation, it is difficult to know the exact conduct of firms in a competitive oligopoly. Despite the model suggesting that prices would remain constant, we often see price wars in real life in the mobile network industry or the supermarket industry, where some supermarket brands offer prices matches due to firms like Iceland, Lidl and Aldi pushing down prices. Furthermore, since firms rely on non-price factors such as advertising to compete, this makes it even more difficult for the smaller or newer firms in a market. Firms end up wasting resources on advertising just to stay in the market, and this means they have less chance of achieving efficiencies. For example, more advertising costs mean less supernormal profit so dynamic efficiency becomes more difficult to achieve. Secondly, higher costs might mean higher prices which means allocative efficiency is difficult to achieve. We also see that, since firms are still profit maximisers, and they are likely to exploit ther price making power wherever possible. For example, Burger King is part of a competitive oligopoly, but since they have stores in airports and train stations, they are able to act as a local monopoly and charge high prices as they know they can exploit customers who have an inelastic demand for food due to the lack of substitutes in an airport.