Cambridge International as and a level Economics Ebook

limit pricing
. This involves 
deliberately setting a low price and temporarily abandoning 
profit maximisation as their objective to deter new entrants. 
It may be in the interest of all the firms to do this and if they 
agree, it becomes a form of collusion.
■ 
Collaboration between existing producers to develop new 
products may act as a barrier in that the resources necessary 
to compete are beyond the means of single new producers.
■ 
Market conditions, such as a fall in demand resulting from 
recession, can leave producers with surplus productive 
capacity and this will deter entry.
Limit pricing: 
where firms deliberately lower prices and 
abandon a policy of profit maximisation to stop new firms 
entering a market.
KEY TERM
Where the barriers are strong, the market is likely to be 
dominated by a few large producers. New fi rms will only 
enter if they think that the economic returns will be greater 
than the cost of breaking down the barriers to entry.
Th
e concept of barriers to entry is central to 
understanding where the models of oligopoly and 
monopoly fi t within the spectrum of competition.
Microsoft Windows and Off ice soft ware: a patented product
Oligopoly
Oligopoly is defi ned as a market situation where the total 
output is concentrated in the hands of a few fi rms. It is 
possibly the most realistic model of market structure 
but, ironically, the theory does not provide the defi nite 
predictions regarding the price and output of the fi rm 
that exist in every other model. An eff ective oligopoly can 
exist in an apparently competitive industry even when a 
handful of fi rms dominate the market.
An oligopoly has the following characteristics:
■ 
The market is dominated by a few firms.
■ 
Their decisions are interdependent. Firms must decide their 
market strategy to compete with close rivals, but they must 
also try to anticipate their rivals’ reactions and think what 
the next step should be in the light of this response.
■ 
There are high or substantial barriers to entry.
■ 
The products may be diff erentiated or undiff erentiated.
■ 
The uncertainty and risks associated with price competition 
may lead to price rigidity.
Th
ere are many examples of oligopolistic markets. Th
e 
telecommunications industry in Pakistan is like this (see 
Self-assessment task 7.7). Th
e retail grocery supermarket 
business in the UK is a particularly good example; Tesco, 
Asda, Sainsbury’s and Morrison’s have more than 70% of 
the market. Another very relevant example is the growing 
car manufacturing and assembly industry in China (See 
Figure 7.18
).
Th
e diffi
culty in studying oligopoly is that behaviour 
can follow two very diff erent routes. Th
ere is evidence of 
aggressive competition in some industries, while in others 
there is a suggestion of cooperation and even collusion.
Oligopolists are price makers but one of the dangers of 
using this weapon is that the fi rm can get drawn into a price