Part A – Microeconomics
Based on the article of King (2013), it appears that the Australian banks have been operating in an oligopoly market. This is because the market is dominated by four biggest banks, namely Commonwealth Bank, Westpac, ANZ and NAB (King, 2013; McConnel et al., 2012, pp. 223-224). According to the Parliament of Australia’s report (2010, p. 42), the Big Four banking institutions controlled more than 75% of assets and deposits as of October 2008.
King (2013) suggests that the Australian banking system was characterized by a middle degree of bank competition. The Reserve Bank of Australia (2017, p. 9) finds that tough financial conditions made it difficult to small banks, especially those who heavily reliant on wholesale banking model, to survive after the GFC. Therefore, the market share of Big 4 banks has been maintained at around 80% of assets and deposits without a large number of new entrants (the Reserve Bank of Australia, 2017, p. 9). However, as governments require more retail deposits, the degree of competition among those Aussie major banks is heightened to attract more sources of sticky funding from their clients (the Reserve Bank of Australia, 2017, p. 10).
If the largest Australian four banks decided to collude and form a cartel with each other, this cartel group is expected to exercise a dominant power like a monopoly in the banking market. This is illustrated by the figure below.
Figure 1 When the four largest Australian banks form a cartel
According to Reserve Bank of Australia (2017), the government wants to increase competition such as preventing a merger amongst the four largest banks (cartel formation). This is because competition is expected to increase economic of scale and ensure allocative efficiency. To illustrate, if a banking institution can control more than 80% of market share, this mega bank can charge excessively high prices (i.e. high borrowing costs) and engage in highly risk-taking activities because of too-big-to-fail phenomenon. In this case, without collusion, each bank cannot enjoy economic profit given a cartel price, as illustrated in above figure. They will follow their individual pricing model given other rivals’ pricing actions like in kinked demand or game strategy theory.
A positive economic profit (average total cost greater than economic cost) will likely to attract new entrants to the competitive market. However, when a large number of new firms enter into the market, an increase in supply will gradually eliminate the economic profit of existing firms. Consequently, several companies must exit the market when their price is lower than the average total costs in the long run. This is presented in the following graph with perfectly competitive market.
Figure 2 Competitive market entry
Figure 3 Market exit
Part B – Macroeconomics
Dolamore (2011) claim that a discretionary fiscal...