Explain why prices tend to be relatively rigid in oligopolistic markets.

Discuss whether an oligopolistic firm should collude rather than compete.

Answers may include:

• definition of oligopoly
• diagram to show the kinked demand curve with price inelastic demand below the market price and price elastic demand above the market price
• explanation of price rigidities, with reference to the risk of price wars and/or with reference to the effect that a change in price would have on the total revenue of the oligopolistic firm
• examples of industries where there are rigid prices/non-price competition/strategic interdependence.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part A.

Answers may include:

• definitions of oligopoly, collusion
• diagram to show open/formal collusion (single, downward-sloping demand curve as in monopoly diagram)
• explanation of how open/formal collusion would limit competition between member firms and maximize joint profits as if the firms were collectively a monopoly and/or the term “tacit collusion”, including reference to price leadership by a dominant firm
• examples of where firms have colluded
• synthesis or evaluation (discuss).

Discussion may include: consideration of the arguments in favour of collusion – economic (abnormal) profits (which can be re-invested in research and development and/or distributed to the shareholders); consideration of the arguments in favour of competition: lower prices and higher quantity for consumers, improved product quality/variety, increased market share for the competing firm(s), improved allocative and/or productive efficiency, difficulties of maintaining cartel structures due to the incentive of cartel members to cheat.

Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.

NB Definitions, theory, and examples that have already been given in part (a), and then referred to in part (b), should be rewarded.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part B.