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Is an oligopolistic market structure an example of market failure?

Introduction One constructive approach of categorizing a market is by dividing it in terms of the number of firms on the supply side of the market and the buyers’ concentration on the demand side. Oligopoly represents one of the market structure where there are a very few firms on the supply side and a huge concentration of buyers on the demand side. As the buyers cannot affect the market conditions, they are going to adopt it as such and the supplier will be busy in anticipating the rival behavior.
Oligopoly looms large in industries of steel, petroleum, automobiles etc. Many industries can operate geographically as oligopolies. For example banking in a small town operate as oligopoly since there will be one or two banks in the area and the residents will be forced to take his business to the local banks.( Friedman, 1983)
Oligopoly a complex market structure Oligopoly is virtually a big business. Under this market structure, the rivalry takes on its worst form. Product innovations, aggressive advertising and innovative marketing tactics are frequently applied to outweigh each other. Oligopolistic market structures are the most difficult to analyze as they are highly interdependent and interwoven, where moves and countermoves are taken rapidly. For example a simple action by Ford may lead to a reaction by General Motors, which in turn cause a readjustment in Ford’s plan, thereby modifying GM’s response and so on. So anything can happen anytime in oligopoly.
There are few models that highlight oligopolistic behavior. They are:
Cartels A case arises in monopoly when all the firms attempt to promote interdependence and they all mutually agree to set price and output. The firms through their mutual coordination try to create a giant monopoly. OPEC (Organization of Petroleum Exporting Countries), is an example of a cartel platform.
Price leadership and Tacit Collusion It is an arrangement in which one or two firms make an arrangement for the pricing for the entire firm. Other firms are forced to follow the same price pattern although no such agreement exists in the industry.
For example: In the infant formula industry, Abbot laboratories, Bristol Myers Squibb and American Home Products deliberately set their prices closer to each other to dominate the industry.
The Kinked Demand Curve This model elaborates the stickiness in pricing in an oligopolistic structure. It has been hypothesized in this model that if for example, a firm X lowers its price in an oligopolistic market, the rival will be forced to lower its price to in order to avoid the loss of its market base. The demand curve dd is thus the relevant curve in case of a price reduction.
dHowever, if the firm X goes for a price increase, then the case won’t be the same. The rivals will not imitate this time, and would continue to enjoy the customer support as they would flee the firm X products. In this case the demand curve would be DD. The firm then tries to remain in a segment of the elastic demand curve between dd and DD. The true demand curve is represented by DAd, known as the kinked demand curve which silently points out the fact “heads you lose, tails you lose” (Baumol and Blinder, 2009)
D
A
Price
8
(Competitors prices are fixed)
7
D
d
(Competitors respond to price changes)
0
Quantity per year
1,400
1,100
1,000
Game theory and the Oligopoly Game theory has been formulated to understand the behavior of the firms in an oligopolistic market structure that do not work on a collaborated output and pricing. The underlying assumption is that the large bossy firms are like players in a game of poker. They make the moves of lowering or increasing the price, to advertise or not to advertise, to discount and so on, based on their rivals’ move. Understanding the payoffs can put a firm in a better position to compete with its rival and be in a profit maximizing and rational position.
For example the game between two coffee shops is illustrated as below:
C:Documents and SettingsAnumDesktop4th assignmentUnderstanding Oligopoly Behavior – a Game Theory overview Economics in Plain English_filesgame-theory-1.jpeg
Source: Welker, J. (2009).Understanding oligopoly behavior-A game theory overview. Available from: http://welkerswikinomics.com/blog/2009/12/15/understanding-oligopoly-behavior-a-game-theory-overview//
According to the above figure, both San Francisco coffee and Starbucks is following a dominant strategy. They are working up to maximize their outcome through advertising, ignoring what their competitor does. If S.F advertises, Starbucks earns profit ($12 vs. $10) through advertising. This means the “pay offs” are the same. Since both firms are enjoying profit through advertising they will do so, though the total profits are less in case when both are advertising, as compared to when they are not advertising. But such a condition would be a condition of instability, as to advertise is likely to be beneficial for both. So we say that advertise/advertise is Nash equilibrium, as at this stage none of the firm is going to change its strategy since it is bringing incentive to both (Jason Welker, 2009).
Market failure due to Oligopoly Keeping in view the above theories that tries to explain oligopolistic behavior, the market failure due to oligopoly can be attributed to a various causes. Inefficiency, instability and indeterminacy brought about by oligopoly may result in a market crash. The firm’s supremacy is established as the capacity is established more and more, but little is produced in order to create artificial barrier to entry. The competitors compete on the basis of non pricing factors such as heavy advertising, which gives more hold up to the artificial barrier to entry. Prices are well above cost and price discrimination prevails. Some of the firms also engage in self-regulation to preserve their own profits and market share that further detoriate the situation (Grewal and Kumnick, 2006). Oligopolistic firms output and prices substantially differ from what is socially accepted from them. It is also believed that the misleading advertisement by the large firms also misleads the consumers and compels them to buy products that they do not want. They impose political and economic power and hover over the mind of the consumers working like an invisible hand.
Market Form
Number of firms in the market
Frequency in Reality
Entry Barriers
Public Interest Results
Long Run Profit
Equilibrium Conditions
Oligopoly
Few
Produces Large share of GDP
Varies
Varies
Varies
Varies
Source: Economics: Principles and Policy By William J. Baumol, Alan S. Blinder
MC=MR applies for a profit maximizing firm, under equilibrium. However, in oligopoly, MC is usually unequal than MR mainly because in oligopoly the firms are seeking to adopt strategies in accordance with the game theory, or they look for techniques such as increasing sales for profit maximization as their ultimate goal.
Conclusion In a perfectively competitive market place the behavior of the firms automatically lead to a maximization of consumer benefits through an efficient allocation of resources. In oligopoly however, resource allocation is usually is not well set, more focused is paid on restricting output in an attempt to maneuver prices and profits. In an oligopoly everything is possible, can happen anytime anywhere, so the economists are still unable to clearly predict its behavior. Besides, its ability to lead the market down, some economists are of the belief that oligopoly has made a significant contribution towards the economic growth in the past two decades resulting in an increase in the average income of the rich countries.(Baumol and Blinder, 2009).
Question two What are the implications for management of businesses in such structures? Introduction Oligopoly is a market characterized by few firms. Managers of a firm in such a structure know that their firm enjoys a market power. But the other players also have their share of power too. If the managers take the right course of action, properly assessing the behavior of their rivals in the industry, they are likely to make a profit.
Strategic behavior Strategic behavior refers to the firm’s ability of proper consideration of their market power and awareness of their rival’s move. Strategic behavior occurs in oligopolistic structures where there is less product differentiation and a competitive industry exists (Taylor and Weerapana, 2009)
Implication for the managers The most important implication for the managers regarding oligopoly is the pricing practice on the basis of mutual interdependence. In case of monopoly, the absence of competition enables the managers to follow the MR=MC role to maximize its profit. Simply following the MR=MC isn’t just enough.
Example Consider, for example the case of proctor and gamble, where the manager hires a consultant for the thorough analysis of the cost, structure and demand. After a detailed analysis of the structure of the body soap products, the manager follows the MC=MR rule and set the retail price at $1.99.In a sudden move, the competitors Colgate-Palmolive , Lever brothers etc set the price of the comparable product 10 to 15 below to that of proctor and gamble. What the manager is likely to do? Either he can go for advertising and heavy promotion to compete against the lower prices of the competitors or can lower its prices down. Or he can simple do nothing if he is confident enough of the strong loyalty that his brand enjoys among consumers. The point is that, that pricing in oligopolistic structure cannot be done without taking into account your competitor. This is the essence of mutual interdependence (Young and McAuley,1994)
The second implication for the managers is to understand that it can be extremely difficult to make money in a competitive market. Firms are required to be as much cost efficient as possible because they cannot control the prices.
The managers are supposed to be vigilant enough to be able to spot opportunities and enter the market before the others could enter. They should be able to make their place before the demand gets high enough to support an above normal price.
A situation could arise in oligopoly, where the managers in a firm become so successful in beating up the competition that the firm turns into a monopoly, or the one that can exercise monopolistic power. Such a case happened with IBM when In 1969, the firm dominated the computer market so much so, that the department of Justice had to issue an antitrust suit against it (Keat, Young and Benerjee, 2009)
Global implication for managers The managers should keep in mind that the process of benchmarking in an oligopolistic structure strategy formulation should be done keeping in view both domestic as well as the global competitors.
For example AT

Rental Volatility In Commercial Property Markets Economics Essay

This Report has several aims and it sets out to explain what rental volatility is, the main causes of rental volatility, identify current annual changes in real estate, property market life cycles, Investment and Development markets and the wider Economy with the aid of up to date Statistics and Charts and ascertain the important drivers of the pricing of different lease terms in the UK property sector.
The research uses data derived from major databases maintained by IPD and various real estate service providers such as GVA Grimley, Ryden, Atisreal, JLL, CBRE, Drivers Jonas, Knight Frank, and DTZ. Along with the extensive online resources I will look towards lecture notes provided by Dr Michael White for guidance on the topic, aswell as relevant textbooks recommended to me in my course of study.
2. Risk
2.1 Rental Volatility
Rental volatility is a measure of how high and low the Annual % Change in real Rents moves within a specified time period, usually displayed from the 1970 – Current obtainable statistical data. Several indicators have been developed over the years, such as Changes in GDP, consumer’s expenditure; service sector employment and industrial output are interlinked and impact on demand for commercial real estate. Although we will be focusing on Micro Economic factors in relation to Rental volatility, research shows that fluctuations in property markets, particularly, in the late 1980s, can be related to changes in the macro economy and to the property development sector’s ability to meet changes in demand for property.
2.2 Factors causing Rental Volatility
Rental market volatility is significant and understanding it is essential to investing in real estate all around the world, so here is a list of the many Factors driving it.
2.2.1 Macro Economic factors:
Economic Growth
Gross Domestic Product (GDP)
Consumer’s Expenditure
Unemployment
Supply and Demand
Cyclical Fluctuations
2.2.2 Micro Economic factors:
Historical Rents
Commercial Property Policies
Tax Ratings
Construction Costs
2.3 Rental volatility in Different Sectors
2.3.1 Office sector
Volatility is displayed in commercial property markets and in the office market major cycles in rents occur in the early 1970s and again in the late 1980s. Most recent cyclical trough has displayed less excess supply than early 1990s, although it clearly shows a dip in the commercial rents in 2009 from the Credit Crunch with Office suffering the most dramatic decline followed by retail and Industrial least affected, this can be put down to the fact that office’s are usually affected by the Macro Economy in terms of service sector occupiers, but office rents have not changed considerably over the period 1970-2007, in spite of significant cycles.
Graph showing the Regional Office Rental growth from 1981 – 2008 2.3.2 Retail Sector
Retail markets are driven by consumer’s expenditure and this is affected by personal disposable income. Macroeconomic variables of interest rates, Tax changes, GDP, Monetary Fiscal policies and unemployment will impact on disposable income; this in turn will determine the public’s willingness to purchase products from the retail sectors. Another factor is Permanent Income; this is what the public expect to spend in the future in regards to Wage income and Asset income (Intertemporal Substitution) thus increasing their consumption of goods due to a higher asset wealth or expected higher wage prospects. In 2007; statistics show a high permanent income in regards to the Increase of house prices but in 2010 there is a massive decline and almost levelling out due to the 2009 Credit Crunch causing the public to reduce their expenditure and save more money.
2.3.3 Industrial Sector
Due to the Decline on Manufacturing in the industrial sector; especially in Developed countries like the UK; warehousing and logistics has become the largest occupier of industrial space and provides a vital support to the UK economy and support a wide range of spatial, economic and transport policy objectives, some cities in key locations may have long term structural advantages for warehousing/logistics and the key to a successful freight strategy is balancing the requirements of operators against impacts. As we see from the sector rental growth graph below, it clearly show that the industrial sector is far more stable than its counterparts, although still dipping in certain areas such as 1992 and the 2009 Credit Crunch; the changes remains less erratic and the lowest Percentage in 1992 was at -8% compared to
-20% of the office sector. This can be attributed to the fact that Industrial Warehousing will not be affected by the same factors as retail and office, whereas Retail considers “Location” as the most important, warehousing is usually situated near transport networks such as motorways which leads to less planning restraints which in turn drives cost/risk down.
Sector Rental Growth: Main Case Forecasts Based upon 2009q2: Latest Sector Rental Growth over three months: Based upon 2010 Q3: All Property rental values are now -10.5% lower than at their peak in April 2008 and are continuing to fall, but the rate of decline is slowing noticeably. Over the three months to March, the IPD Monthly Index reports a decrease of -0.5%, compared with a fall of -1.2% in the last three months of 2009, with falls of -0.7% in the retail and industrial sectors.
3. Commercial Real Estate Markets
3.1 User Markets
Use, or potential use, drives property value and its investment value and a factor of determining rental value comes from demand and supply, shown below is a graph of the Change in lettings and availability. According to the latest RICS Commercial Market Survey with a balance of -10% of respondents reporting a fall in sales and letting activity. This reverses the modest rises reported over the previous two quarters and shows that demand remains fragile, with uncertainty resulting from the budget highlighted as a key factor, with a sharp drop in take-up in Q2 overturning the rises seen over the previous three quarters.
UK 2010 Q2: UK 2010 Q3: 3.2 Investment Markets
Latest statistics provided by GVA Grimley suggest a downward yield movement that has driven the strong performance of prime and good quality secondary property over the last year appears to be coming to a halt. The All Property equivalent yield fell very marginally from 7.57% in May to 7.53% in June. As yields have begun to level off, so capital value growth has slowed noticeably. Falling rental values detracted just -0.4% from capital value growth in the three months to June compared with -2.7% a year ago. Although capital growth is now slowing, the year-on-year figure has continued to rise sharply, reaching 15% pa in June compared with 7.6% pa in March. However, the level of transactions is now reducing, largely in response to a significant reduction in available stock, although a cooling in investor demand has also had an effect. As a result, we expect to see a lower level of transactions to be reported in Q3. With the downward movement that has occurred over the last year, property yields have moved back to a level broadly in line with the average over the last 15 years. Taking into account the subdued outlook for rental growth across most of the market, a further significant downward movement in property yields looks hard to justify.
With the subdued outlook for the economy and rental growth, yields for good quality secondary property could well come under increased pressure to move upwards. At the same time, there could also be some further selective downward move in prime yields.
UK 2010 Q2: UK 2010 Q3: 3.3 Development Market
The definition of the Development market usually means land or property that may possess to have development potential whenever a degree of latent value may be released by the expenditure of capital upon that land or property. Within the development process there carries a certain amount of complexities in the development process and these include site acquisition, obtaining planning permission, transaction costs and arranging finance for short term/long term, within the development cycle, consider a adjustment lags and interaction between development, the real economy and the monetary sector. The diagram below shows the relationship between Investment and Development Markets and allows us to further understand the relationship.
scan0003.jpg
DiPasquale-Wheaton’s Model Examines user, investment and development and provides a graphical illustration of these relationships.
3.4 Wider Economy
Data from Global Market Perspective October 2010 – Jones Lang LaSalle shows that the global economy continues to expand, although the pace of growth is slowing, leading the IMF to lower its projections marginally for the coming year. The US is showing Uncertainty in economic recovery; this is due to the diminishing impact of fiscal stimulus as well as the end of the inventory bounce having combined with a weak housing market. In Europe, there is mounting evidence that the relatively strong Q2 bounce has weakened. News that the tally for rescuing the Irish financial sector could run to over 55% of Irish GDP (or around €50 billion) the Irish rescue Loan causing Corporation tax to rise but not helping raise Growth in the Irish economy, combined with recent credit rating downgrades for Spain and Ireland, have resurrected concerns about European sovereign debt. However Germany has shown remarkable resilience, with a sharp fall in unemployment, growth in exports and strengthening domestic demand boosting German business and consumer confidence.
Global Real Estate Health Monitor:
Commercial Real Estate Return Performance – A Cross-Country Analysis:
Mean Annualized Return (%) Commercial Real Estate Return Performance.jpg
Volatility (Risk) (%) 3.5 Property Market Life Cycles:
The Barras’s Model Identifies the relationship between the property market, economy and the credit market and shows interaction between Property Markets and the Macro economy.
The Process:
If there is a strong economic upturn coinciding with relative shortage of space. Demand for space ↑, rents ↑, yields ↓, capital values ↑. Profitability of development rises, so new buildings are started.
If credit expansion also occurs, interest rates fall reinforcing economic growth and banks begin to fund speculative developments. The building boom will be underway but little new supply on market due to time lags.
In macro economy, inflation will have risen at this stage in the cycle, interest rates rise to control inflation, then the macro cycle moves into a downswing. New space supply reaches the market as demand levels off so rents and capital values fall.
Demand is now falling (in the recessionary phase) so rents fall further, vacant stock increases, property development companies go bankrupt so the next upswing in property will be demand driven, the supply overhang from the previous boom/bust will discourage speculative development leading to volatility of previous cycle to be avoided.
scan0004.jpg
Barras (1994) illustrates how a building boom is generated by the interaction of the business cycle, the credit cycle and the long cycle of development in the property market.
4. Conclusion:
I believe Investment in the UK in the next few years will be a viable and good worthy investment; this is due to the continuing upward shift in growth throughout the Rental markets in Retail, industrial and office Sectors. I advise that if investment were to be made, the Industrial Sector seems to be low risk in regards to the other sectors; remaining very stable in past years and almost levelling out and rising slightly in the 2010-2012 Forecasts. The most risky investment would be the office market, this mainly due to the 2009 Credit crunch has caused a massive dip in rental values and vacant stock, the problem is that if investment were to be made in this sector; the economy might fall into another recessionary period causing a double dip and won’t make you any returns on your investment.

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