characteristics of oligopoly essay

Essay on Oligopoly: Top 8 Essays on Oligopoly | Markets | Microeconomics

Here is a compilation of essays on ‘Oligopoly’ for class 9, 10, 11 and 12. Find paragraphs, long and short essays on ‘Oligopoly’ especially written for school and college students.

Essay on Oligopoly

Essay Contents:

• Essay on Payoff (Profit) Matrix

Essay # 1. Introduction to Oligopoly:

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Two extreme market forms are monopoly (characterised by the existence of a single seller) and perfect competition (characterised by a large number of sellers). Competition is of two types- perfect competition and monopolistic competition. In perfect competition, all sellers sell ho­mogeneous products while in monopolistic competition they sell heterogeneous products. In monopoly there is no rival.

So the monopolist is not concerned with the effect of his actions on rivals. In both types of competition, the number of firms is so large that the actions of any one seller have little, if any, effect on its competitors. An industry with only a few sellers is known as an oligopoly, a firm in such an industry is known as an oligopolist.

Although car-wash is a million rupee business, it is not exactly a product familiar to most consumers. However, often many familiar goods and services are supplied only by a few com­peting sellers, which means the industries we are talking about are oligopolies. An oligopoly is not necessarily made up of large firms. When a village has only two medi­cine shops, service there is just as much an oligopoly as air shuttle service between Mumbai and Pune.

Essentially, oligopoly is the result of the same factors that sometimes produce monopoly, but in somewhat weaker form. Honestly, the most important source of oligopoly is the exist­ence of economies of scale, which give better producers a cost advantage over smaller ones. When these economies of scale are very strong, they lead to monopoly, but when they are not that strong they lead to competition among a small number of firms.

Since an oligopoly con­tains a small number of firms, any change in the firms’ price or output influences the sales and profits of competitors. Each firm must, therefore, recognise that changes in its own policies are likely to elicit changes in the policies of its competitors as well.

As a result of this interdependence, oligopolists face a situation in which the optimal deci­sion of one firm depends on what other firms decide to do. And so there is opportunity for both conflict and cooperation. Oligopoly refers to a market situation in which the number of sellers is few, but greater than one. A special case of oligopoly is monopoly in which there are only two sellers.

Essay # 2. Characteristics of Oligopoly:

The notable characteristics of oligopoly are:

1. Price-Searching Behaviour :

An oligopolist is neither a price-taker (like a competitor) nor a price-maker (like a monopolist). It is a price-searcher. An oligopolist is neither a big enough part of the market to be able to act as a monopolist, nor a small enough part of the market to be able to act as a competitor. But each firm is a dominant part of the market.

In such a situation, competition among buyers will force all the sellers to charge a uniform price for a product. But each firm is sufficiently so large a part of the market that its actions will have noticeable effects upon his rivals. This means that if a single firm changes its output, the prices charged by all the firms will be raised or lowered.

2. Product Characteristics :

In oligopoly, there may be product differentiation as in monopolistic competition (called differ­entiated oligopoly) or a homogeneous product may be traded by all the few dominant firms (as in pure oligopoly).

3. Interdependence and Uncertainty :

In oligopoly no firm can take decision on price independently. It is because the decision to fix a new price or change an existing price will create reactions among the rival firms. But rivals’ reactions cannot be predicted accurately. If a firm reduces its price its rivals may reduce their prices or they may not. So there is lack of symmetry in the behaviour of rival firms.

This type of reaction of rivals is not found in perfect competition or monopolistic competition where all firms change their price in the same direction and by the same magnitude in order to remain competitive and survive in the long run. So the outcome of a firm’s decision is uncertain.

For this reason it is difficult to predict the total demand for the product of an oligopolistic industry. It is still more difficult, and in some situations virtually impossible, to estimate the share of an individual firm in industry’s output.

It is true that the consequences of attempted price variations on the part of an individual seller are uncertain. His rivals may follow his change, or they may not, but they will, in all likelihood, notice it. The results of any action on the part of an oligopolist or even a duopolist depend upon the reactions of his rivals. In short, it is not possible to define general price- quantity relations for an individual firm, since reaction patterns of rivals are highly uncertain and almost completely unknown.

4. Different Reaction Patterns and Use of Models :

It is not true to say that, in oligopoly, profit is always maximised. It is because an oligopolist does not have control over all the variables which affect his profit. Moreover, a variety of possible reaction patterns is possible in this market—there is a conjectural variation in this market.

Just as firm A’s profit depends on the output of firm B also, firm B’s profit, in its turn, depends on firm A’s output. This is why various models are used to describe the diverse behaviour of oligopoly markets where a variety of outcomes is possible.

5. Non-Price Competition :

As in monopolistic competition there is not only price competition but non-price competition as well in oligopoly (and, to some extent, in duopoly). For example, advertising is often a life and death question in this type of market due to strategic behaviour of all firms. In most oligopoly situations we find intermediate outcomes. Economists are yet to emerge with a definite behaviour pattern in oligopoly.

Essay # 3. Scope of Study of Oligopoly :

Here we study a few of the many possible reaction patterns in duopoly and oligopoly situa­tions. The focus is on pure oligopoly. Here we assume that all firms produce a homogeneous product. We do not discuss the case of differentiated oligopoly and the issue of selling cost (advertising) separately. Of course, we discuss briefly Baumol’s sales maximisation hypoth­esis—without and with advertising.

The focus here is on the interdependence of the various sellers’ reactions, which is the essential distinguishing feature of oligopoly. If the influence of one seller’s quantity decision from the profit of another, δπ i /δq j , is negligible, the industry must be either perfectly competi­tive or monopolistically competitive. If δπ i /δq j , is perceptible, the industry is duopolistic or oligopolistic.

The optimum quantity and maximum profit of a duopolist or oligopolist depend upon the actions of the firms belonging to the industry. He can control only his own output level (or price, if his product is differentiated), but he has no direct control over other variables which are likely to (or do) affect his profits. In truth, the profit of each oligopolist is the result of the interaction of the decisions of all players in the market.

Since there are no generally accepted behavioural assumptions for oligopolists and duopolists as is found in other market forms, there are diverse patterns of behaviour and many different solutions for oligopolistic and duopolistic markets. Each solution is based on different types of models and each model is based on a different behavioural assumption or a set of assumptions.

Here we start with one or two simple duopoly models. The same analysis (solution) can be extended to cover any oligopolistic market. The earliest model of duopoly behaviour is the Cournot model, with which we may start our review of different oligopoly models. We end with the game theoretic treatment of oligopoly which shows decision-making under conflict.

Essay # 4. Models of Oligopoly:

1. the cournot model :.

The Cournot model (presented in 1838) is based on the analysis of a market in which two firms produce a homogeneous product. Augustin Cournot (a French economist) noticed that only two firms were producing mineral water for sale. He argued that each firm would choose quan­tity that would maximise profit, taking the quantity marketed by its competitor as given.

Two main features of the model are:

(i) Each firm chooses a quantity of output instead of price; and

(ii) In choosing its output each firm takes its rival’s output as given.

In Cournot’s model, then, strategies are quantities of output. Here we assume that firms produce a homoge­neous good and know the market demand curve.

Each firm must decide how much to produce, and the two firms make their decisions at the same time. When taking its production decision, each duopolist takes into consideration its competitor. It knows that its competitor is also de­ciding how much to produce, and the market price will depend on the total output of both firms.

The essence of the Cournot model is that each firm treats the output level of its competitor as fixed and then decides how much to produce. Each Cournot’s duopolist believes that the other’s quantity will not change. In Fig. 1 when I produces Q M , II maximises its profit by producing 1/4Q C . In order to sell Q M plus Q c , the price must fall to P 1 . Here Q M is the mo­nopoly output which is half the competitive output Q c .

The inverse demand function, stating price as a function of the aggregate quantity sold, is expressed as:

P =f (q 1 ) + q 2 … (1)

where q 1 and q 2 are the output levels of the duopolists. The total revenue of each duopolist depends upon his own output level as also as that of his rival:

R 1 = q 1 f 1 (q 1 + q 2 ) = R 1 (q 1 , q 2 )

R 2 = q 2 f 2 (q 1 + q 2 ) = R 2 (q 1 , q 2 ) … (2)

The profit of each equals his total (sales) revenue, less his cost, which depends upon his output level above:

π 1 = R 1 (q 1 , q 2 ) – C 1 (q 1 )

π 2 = R 2 (q 1 , q 2 ) – C 2 (q 2 ) … (3)

The basic behavioural assumption of the Cournot model is that each duopolist maximises his profit on the assumption that the quantity produced by his rival is invariant with respect to his own decision regarding output quantity. Duopolist I maximises π 1 with reference to q 1 , treating q 2 as a parameter, and duopolist II maximises π 2 , with reference to q 2 , treating q 1 as a parameter. Setting the partial derivatives of (3) equal to zero, we get:

The solution of (7) is

Here OM is the marginal cost of producing the commodity. The second firm’s price is p 2 . The first firm’s profit function is composed of three segments. When p 1 < p 2 , the first firm captures the entire mar­ket, and its profit increases as its price increases. When p 1 > p 2 , the two firms split the total profits equal to distance CA, and each makes a profit equal to CB. When p 1 >p 2 , the first firm’s profit is zero because it sells nothing when its price exceeds the second firm’s price.

Criticisms:

The Bertrand model has been criticised on two main grounds. First, when firms produce a homogeneous good, it is more natural to compete by setting quantities rather than prices. Second, even if firms do set prices and choose the same price (as the model predicts), what share of total sales will go to each one? The model assumes that sales would be divided equally among the firms, but there is no reason why this must be the case.

However, despite these shortcomings, the Bertrand model is useful because it shows how the equilibrium out­come in an oligopoly can depend crucially on the firms’ choice of strategic variable.

3. The Stackelberg Model :

The Stackelberg model (presented by the German economist Heinrich von Stackelberg) is a modified version of the Cournot model. In the Cournot model, we assume that two duopolists make their output decisions at the same time. The Stackelberg model examines what happens if one of the firms can set its output first. The Stackelberg model of duopoly is different from the Cournot model, in which neither firm has any opportunity to react.

The model is based on the assumption that the profit of each duopolist is a function of the output levels of both:

π 1 = g 1 (q 1 , q 2 ) π 2 = g 2 (q 1 , q 2 ) … (1)

The Cournot solution is found out by maximising π 1 with reference to q 1 , assuming q 2 to be constant and π 2 with reference to q 2 , assuming q 1 to be constant. In general, each firm might make some other assumption about the response (reaction) of its only rival. In such a situation, profit-maximisation by the two duopolists requires the fulfillment of the following two condi­tions:

Since the firm’s demand curve is kinked, its combined marginal revenue curve is discon­tinuous. This means that the firm’s cost can change without leading to price change. In this figure, marginal cost could increase but would still equal marginal revenue at the original out­put level. This means that price remains the same.

The kinked demand curve model fails to explain oligopoly pricing. It says nothing about how marginal revenue firms arrived at the original price P̅ to start with. In fact, some arbitrary price is taken as both the starting and end point of our journey. Why firms did not arrive at some other price remains an open question. It just describes price rigidity but cannot explain it. In addition, the model has not been supported by empirical tests. In reality, rival firms do match price increases as well as price cuts.

Market-sharing Price Leadership :

Oligopolists often collude—jointly restrict supply to raise price and cooperate. This strategy can lead to higher profits. Collusion is, however, illegal. Moreover, one of the main impedi­ments to implicitly collusive pricing is the fact that it is difficult for firms to agree (without talking to each other) on what the price should be.

Coordination becomes particularly problem­atic when cost and demand conditions—and, thus, the ‘correct’ price—are changing. However, benefits of cooperation can be enjoyed without actually colluding. One way of doing this is through price leadership. Price leadership may be provided by a low-cost firm or a dominant firm.

In this context, we may draw a distinction between price signalling and price leadership. Price signalling is a form of implicit collusion that sometimes gets around this problem. For example, a firm might announce that it has raised its price with the expectation that its competi­tors will take this announcement as a signal that they should also raise prices. If competitors follow, all of the firms (at least, in the short run) will earn higher profits.

At times, a pattern is established whereby one firm regularly announces price changes and other firms in the industry follow. This type of strategic behaviour is called price leadership— one firm is implicitly recognised as the ‘leader’. The other firms, the ‘price followers’, match its prices. This behaviour solves the problem of coordinating price: Everyone simply charges what the leader is charging.

Price leadership helps to overcome oligopolistic firms’ reluctance to change prices—for fear of being undercut. With changes in cost and demand conditions, firms may find it increas­ingly necessary to change prices that have remained rigid for some time. In that case, they wait for the leader to signal when and by how much price should change.

Sometimes a large firm will naturally act as a leader; sometimes different firms will act as a leader from time to time. In this context, we may discuss the dominant Firm model of leadership. This is known as market- sharing price leadership.

6. The Dominant Firm Model :

In some oligopolistic markets, one large firm has a major share of total sales while a group of smaller firms meet the residual demand by supplying the remainder of the market. The large firm might then act as a dominant firm, setting a price that maximises its own profits.

The other firms, which individually could exert little, if any, influence over price, would then act as perfect competitors; they all take the price set by the dominant firm as given and produce accordingly. But what price should the dominant firm set? To maximise profit, it must take into account how the output of the other firms depends on the price it sets.

Fig. 5 shows how a dominant firm sets its prices. A dominant firm is one with a large share of total sales that sets price to maximise profits, taking into account the supply response of smaller firms. Here D is the market demand curve and S F is the supply curve (i.e., the aggregate marginal cost curves of the smaller firms, called competitive fringe firms). The dominant firm must determine its demand curve D D .

This curve is just the difference between market demand and the supply of fringe firms. For example, at price P 1 , the supply of fringe firms is just equal to market demand. This means that the dominant firm can sell nothing at this price. At a price P 2 or less, fringe firms will not supply any of the good, in which case, the dominant firm faces the market demand curve. If price lies between P 1 and P 2 , the dominant firm faces the demand curve D D .

The marginal cost curve of the dominant firm corresponding to D D is MR D . The dominant firm’s marginal cost curve is MC D . In order to maximise its profit, the dominant firm produces quantity Q D at the interaction of MR D and MC D . From the demand curve D D , we find P 0 . At this price, fringe firms sell a quantity Q F , thus the total quantity sold is Q T = Q D + Q F .

7. Collusive Oligopoly: The Cartel Model :

Various models have been formulated to explain the strategic behaviour of firms in an oligopolistic market. A price (cut-throat) competition exists among the rivals who try to oust the others from the market. Sometimes there ex­ists a dominant firm that acts as the leader in the market while the others just follow the leader.

As a result, there happens to be a clear possibil­ity of the formation of a cartel by the rival firms in an oligopolistic market in order to eliminate competition among themselves. This is termed as “collusive oligopoly” because the firms some­how manage to combine together in order to be­have collectively as a single monopoly.

Now let us see graphically what incentives the firms get for forming a cartel. In Fig. 6, the market demand curve is given by the D M the total supply curve is the horizontal summation of the marginal cost curves of all existing firms in the industry, which is denoted by MC M .

The market equilibrium is attained at the point of intersection between the D M (demand curve) and the marginal cost curve MC M , if the firms compete with each other. OP M is the equilibrium price at which the total output of the industry is OQ M .

In order to determine its own quantity, each firm equates this price to its marginal cost. The sum of the quantities of the firms is OQ. If the firms form a cartel in order to act as a monopolist, the price rises to OP ‘ M and the quantity is reduced to OQ ‘ M to be in equilibrium. Now, when the quantity is being reduced by Q M Q’ M , then all the firms together save the cost represented by the area below the MC M curve which is Q M E M F M Q ‘ M .

Thus, a rise in price due to a reduction in the quantity is followed by a decrease in the total revenue represented by the area below the MR M curve, i.e., area Q M G M F M Q’ M . This, in turn, shows that the cost saved exceeds the loss in revenue and, so, all the firms taken as a whole can increase their profit represented by the area E M F M G M . The prospect of earning this extra profit actually acts as the incentive to form a cartel in the oligopoly market structure.

Since the cartel is formed, all firms agree together to produce the total quantity OQ’ M . In order to carry this out, each and every firm is allotted a quota or a certain portion of production such that the sum of all quotas is equal to OQ M . For this, the best way of quota allotment would be to treat each firm as a separate entity (plant) under the same monopolist. Thus, all the firms have the same marginal cost (MC) such that MC = MR (marginal revenue).

Finally, the total profit is maximised because the total output is produced at the minimum cost.

Each and every firm can increase its profit by reducing the profits of other firms, simply by increasing its output quantity above the allotted quota. The system of cartel formation must guard against the desire of individual firms to violate the quota and the cartel breaks down when the cost of guarding against quota violation is very high.

The OPEC is an example of collusive oligopoly or cartel in which members (producers) explicitly agree to cooperate in setting prices and output levels. All the producers in an industry need not and often do not join the cartel. But if most producers adhere to the cartel’s agree­ments, and if market demand is sufficiently inelastic, the cartel may drive prices well above competitive levels.

Two conditions for success:

Two conditions must be fulfilled for cartel success. First, a stable cartel organisation must be formed whose members agree on price and production levels and both adhere to that agreement. The second condition is the potential for monopoly power. A cartel cannot raise price much if it faces a highly elastic demand curve. If the potential gains from cooperation are large, cartel members will have more incentive to share their organisa­tional problems.

Analysis of Cartel Pricing:

Cartel pricing can be analysed by using the dominant firm model of oligopoly. It is because a cartel usually accounts for only a portion of total production and must take into account the supply response of competitive (non-cartel) producers when it sets price. Here we illustrate the OPEC oil cartel.

Fig. 7 illustrates the case of OPEC. Total demand TD is the world demand curve for crude oil, and S c is the competitive (non-OPEC) supply curve. The demand for OPEC oil D 0 is the difference between total demand (TD) and competitive supply (SC), and MR 0 is the corresponding marginal revenue curve.

MC 0 is OPEC’s marginal cost curve; OPEC has much lower production costs than do non-OPEC producers. OPEC’s marginal revenue and marginal cost are equal at quantity Q 0 , which is the quantity that OPEC will produce. Here we see from OPEC s demand curve that the price will be P 0 .

Since both total demand and non-OPEC supply are inelastic, the demand for OPEC oil is also fairly inelastic; thus the cartel has substantial monopoly. In the 1970s, it used that power to drive prices well above competitive levels.

In this context, it is important to distinguish between short-run and long-run supply and demand curves. The total demand and non-OPEC supply curves in Fig. 7 apply to short-or intermediate-run analysis. In the long run, both demand and supply will be much more elastic, which means that OPEC’s demand curve will also be much more elastic.

We would thus expect that, in the long run, OPEC would be unable to maintain a price that is so much above the competitors’ level. In truth, during 1982-99, oil prices fell steadily, mainly because of the long- run adjustment of demand and non-OPEC supply.

However, cartel is not an unmixed blessing. No doubt cartel members can talk to one an­other in order to formalize an agreement. But it is not that easy to reach a consensus. Different members may have different costs, different assessments of market demand, and even different objectives, and they may, therefore, want to set prices at different levels.

Furthermore, each member of the cartel will be tempted to “cheat” by lowering its price slightly to capture a larger market share than it was allotted. Most often, only the threat of a long-term return to competi­tive prices deters cheating of this sort. But if the profits from cartelization are large enough, that threat may be sufficient.

Essay # 5. Sales (Revenue) Maximisation :

W.J. Baumol presented an alternative hypothesis to profit maximisation, viz., sales (revenue) maximisation. He has suggested that large oligopolistic firms do not maximise profit, but rather maximise sales revenue, subject to the constraint that profit equals or exceeds some minimum accepted level. Various empirical studies support Baumol’s hypothesis. And it accurately cap­tures some aspects of oligopolistic firms’ behaviour.

Most important, when firms are uncertain about their demand curve they actually face, or, when they cannot accurately estimate the marginal costs of their output (due to uncertainty about factor prices, or when they produce more than one product), the decision to try to maximise sales appears to be consistent with their long-term survival. This is why many oligopolist firms seek to maximise their market share in order to protect themselves from the adverse effects of uncertain market environment.

Graphical Analysis :

A revenue-maximising oligopolist would choose to produce that level of output for which MR = 0. When MR = 0, TR is maximum. That is, the oligopolist should proceed to the point at which selling any extra unit(s) actually leads to a fall in TR. This choice is illustrated in Fig. 8.

For the firm which faces the demand curve D, TR is maximum when output is q s . For q < q s , MR is positive. This means that selling more units increases TR (though not necessarily profit). For q > q s , however, MR is negative. So further sales actually reduce TR because of price cuts that are necessary to induce consumers to buy more. We know that

MR = P(1 – 1/e p ) … (1)

MR = 0 if e p = 1, in which case TR will be maximum. TR is constant in a small neighbourhood of that output quantity at M 1 P = 0, TR is maximum, and when TR is maximum, e p = 1.

We may now compare the revenue-maximisation choice with the profit-maximising level of output, q s . At q p , MR equals marginal cost MC in Fig. 8. Increasing output beyond q p would reduce profits since MR < MC. Even though TR continues to increase up to q s , units of output beyond q p bring in less than they cost to produce. Since marginal revenue is positive at q p , equation (1) shows that demand must be elastic (e p > 1) at this point.

Essay # 6. Constrained Revenue Maximisation :

A firm that chooses to maximise TR is neither taking into account its costs nor the profitabil­ity of the output that it is selling. And it is quite possible that the output level q s in Fig. 8 yields negative profit to the firm. However, it is not possible to any firm to survive for ever with negative profits. So it may be more realistic to assume that firms do meet some mini­mum level (target rate) of profit from their activities.

Thus, even though oligopolists may be prompted to produce more than q p with a view to maximising revenue, they may produce less than q p units in order to ensure an acceptable level of profit. They will, therefore, behave as constrained revenue maximises and will choose to produce an output level which lies between q p and q s .

Mathematical Analysis :

Definition of oligopoly

An oligopoly is an industry dominated by a few large firms. For example, an industry with a five-firm concentration ratio of greater than 50% is considered an oligopoly.

Examples of oligopolies

Car industry – economies of scale have caused mergers so big multinationals dominate the market. The biggest car firms include Toyota, Hyundai, Ford, General Motors, VW.

• Petrol retail – see below.
• Pharmaceutical industry
• Coffee shop retail – Starbucks, Costa Coffee, Cafe Nero
• Newspapers – In the UK market share is dominated by tabloids Daily Mail, The Sun, The Mirror, The Star, Daily Express.
• Book retail – In the UK market share is dominated by Waterstones, Amazon and smaller firms like Blackwells.

The main features of oligopoly

• An industry which is dominated by a few firms.

The UK definition of an oligopoly is a five-firm concentration ratio of more than 50% (this means the five biggest firms have more than 50% of the total market share) The above industry (UK petrol) is an example of an oligopoly. See also: Concentration ratios

• Interdependence of firms – companies will be affected by how other firms set price and output.
• Barriers to entry. In an oligopoly, there must be some barriers to entry to enable firms to gain a significant market share. These barriers to entry may include brand loyalty or economies of scale. However, barriers to entry are less than monopoly.
• Differentiated products. In an oligopoly, firms often compete on non-price competition . This makes advertising and the quality of the product are often important.
• Oligopoly is the most common market structure

How firms compete in oligopoly

There are different possible ways that firms in oligopoly will compete and behave this will depend upon:

• The objectives of the firms; e.g. profit maximisation or sales maximisation?
• The degree of contestability; i.e. barriers to entry.
• Government regulation.

There are different possible outcomes for oligopoly:

• Stable prices (e.g. through kinked demand curve) – firms concentrate on non-price competition.
• Price wars (competitive oligopoly)
• Collusion- leading to higher prices.

The kinked demand curve model

This model suggests that prices will be fairly stable and there is little incentive for firms to change prices. Therefore, firms compete using non-price competition methods.

• This assumes that firms seek to maximise profits.
• If they increase the price, then they will lose a large share of the market because they become uncompetitive compared to other firms. Therefore demand is elastic for price increases.
• If firms cut price then they would gain a big increase in market share. However, it is unlikely that firms will allow this. Therefore other firms follow suit and cut-price as well. Therefore demand will only increase by a small amount. Therefore demand is inelastic for a price cut.
• Therefore this suggests that prices will be rigid in oligopoly

The diagram above suggests that a change in marginal cost still leads to the same price, because of the kinked demand curve.  Profit maximisation occurs where MR = MC at Q1.

Evaluation of kinked demand curve

• In the real world, prices do change.
• Firms may not seek to maximise profits,  but prefer to increase market share and so be willing to cut prices, even with inelastic demand.
• Some firms may have very strong brand loyalty and be able to increase the price without demand being very price elastic.
• The model doesn’t suggest how prices were arrived at in the first place.

Firms in an oligopoly may still be very competitive on price, especially if they are seeking to increase market share. In some circumstances, we can see oligopolies where firms are seeking to cut prices and increase competitiveness.

A feature of many oligopolies is selective price wars. For example, supermarkets often compete on the price of some goods (bread/special offers) but set high prices for other goods, such as luxury cake.

• Another possibility for firms in oligopoly is for them to collude on price and set profit maximising levels of output. This maximises profit for the industry.

In the above example, the industry was initially competitive (Qc and Pc). However, if firms collude, they can agree to restrict industry supply to Q2, and increase the price to P2. This enables the industry to become more profitable. At Qc, firms made normal profit. But, if they can stick to their quotas and keep the price at P2, they make supernormal profit.

• Collusion is illegal, but tacit collusion may be hard to spot.
• For collusion to be effective, there need to be barriers to entry.
• A cartel is a formal collusive agreement. For example, OPEC is a cartel seeking to control the price of oil.

See: Collusion

Collusion and game theory

Game theory is looking at the decisions of firms based on the uncertainty of how other firms will react. It illustrates the concept of interdependence. For example, if a firm agrees to collude and set low output – it relies on the other firm sticking to the collusive agreement. If the firm restricts output (sets the High price), and then the other firm betrays its agreement (setting low price). The firm will be worse off.

• This shows different options. If the market is non-collusive, firms make £4m each.
• If they collude, they make £8m.
• But, if they are colluding there is an incentive for one of the firms to exceed quota and increase output. If a firm sets low price whilst the other sets a high price, their profit rises to £10m

Collusion and game theory is more complex if we add in the possibility of firms being fined by a government regulator.

Collusion is illegal and firms can be fined. Usually, the first firm that confesses to the regulator is protected from prosecution, so there is always an incentive to be the first to confess.

• Pricing strategies
• Diagrams for oligopoly
• Game Theory

Marketing91

Oligopoly: Definition, Characteristics, Types and Examples

August 23, 2023 | By Hitesh Bhasin | Filed Under: Marketing

The characteristics of an oligopolistic market structure include interdependent decisions, a kinked demand curve, and competitive behavior among firms. Interdependence means that each firm takes into account the pricing and output decisions of other firms while making its own decision.

This leads to a kinked demand curve which shows how other firms respond when the price of a product is changed. Lastly, competitive behavior among firms means that each firm tries to outdo its competitors by providing better products or services at lower prices.

The photographic equipment industry is an oligopoly market structure , with high entry and exit barriers, which makes it difficult for new entrants to enter the market. Key characteristics of oligopoly market structures are high concentration, mutual interdependence, price leadership, and non-price competition . The competitors in this market structure are few in number, and they are able to influence each other’s decisions.

Table of Contents

What is Oligopoly?

An oligopoly is a market structure in which there are only a few firms that dominate the industry. It is commonly seen in the automobile, airline, steel, and oil industries where only a few firms produce the majority of products or services. For example, the oil industry is largely dominated by only a few large companies.

Oligopoly markets are characterized by only a few firms dominating the industry and this makes it difficult for new firms to enter the market as they cannot compete with the established ones. This can also lead to higher prices and less innovation in the industry.

An oligopoly is a market structure where two or more firms dominate an industry. Characteristics of oligopoly include price rigidity, product differentiation , interdependence, and barriers to entry . The automobile industry , steel industry, airline industry, and oil companies are all examples of oligopolies.

In an oligopoly market structure, firms have the ability to manipulate prices and increase profits. This is due to the few number of large producers in the industry. With few firms, any one firm in the market can significantly impact price and supply. As a result, firms may try to increase prices and limit production in order to gain larger profits.

Characteristics of Oligopoly

1. high barriers to entry.

Oligopoly markets have high barriers to entry. This means that it is difficult for new firms to enter the market as they are unable to compete with the existing ones.

The price-making powers of large firms also make it hard for newcomers to enter.

2. Price Making Power

Oligopolies have significant pricing power, meaning they can charge prices that are much higher than what they’d be able to in more competitive markets.

This is because a few large firms can collude and set a market price, making it difficult for other firms to enter and undercut them.

3. Interdependence Of Firms

In an oligopoly market structure, each firm takes into account the pricing decisions of its competitors while setting its own prices.

That’s because any change in price by one firm will directly impact the profits of other firms as well.

4. Differentiated Products

Oligopolies usually produce products or services which are either differentiated from their rivals or have some kind of brand loyalty associated with them.

This makes customers less likely to switch providers even when there are lower prices available elsewhere.

5. Non-Price Competition

Oligopolies often engage in non-price competition such as advertising , product quality improvement, and provision of better customer service to differentiate their products from competitors.

This helps them gain an edge over rivals and increase market share .

6. A Few Firms with Large Market Shares

In oligopoly markets, a few large firms dominate the industry and control the majority of the market share .

This makes it difficult for new entrants to compete with established ones even if they offer lower prices or better products or services.

7. Few Sellers

Oligopoly markets are characterized by only a few sellers who produce most of the goods and services being offered in the market.

This makes it difficult for new firms to enter the market and compete with existing ones.

8. Each Firm Has Little Market Power In Its Own Right

In an oligopoly market structure, each firm has only little market power in its own right as all of them are dependent on the pricing decisions of other firms.

This means that any change in price by one firm will have an impact on the profits of other firms as well.

9. Higher Prices than Perfect Competition

Oligopoly markets tend to have higher prices than the perfect competition due to the pricing power of large firms, lack of competition, and lack of incentives for firms to lower their prices.

This can lead to higher profits for these firms but can also be detrimental to consumers .

10. More Efficient

Oligopoly markets tend to be more efficient than perfect competition as they allow firms to take advantage of economies of scale and focus on producing the best quality products at the lowest cost.

This helps them achieve higher profits without having to worry about competing on price.

11. Advertising

Large companies in oligopoly markets often engage in advertising campaigns to differentiate their products from competitors and increase brand loyalty .

This helps them gain an edge over rivals and increase market share, even when other firms offer lower prices or better quality products.

12. Group Behaviour

In oligopoly markets, firms usually act in a group rather than individually due to interdependence among them.

This means that each firm takes into account the pricing decisions of its competitors while setting its own prices.

13. Competition

Oligopoly markets are characterized by competition among a few large firms as opposed to a perfect competition where many small firms compete against each other.

This means that these firms can collude and set a market price, making it difficult for other firms to enter the market and undercut them.

14. Barriers To Entry Of Firms

In oligopoly markets, there are usually high barriers to entry due to economies of scale, the presence of large firms, and brand loyalty from customers.

This makes it very difficult for new entrants to compete with established ones even if they offer lower prices or better products or services.

15. Lack Of Uniformity

Due to the number of firms in the market and their different strategies , oligopoly markets lack uniformity.

This means that prices charged by each firm can be quite different from those set by its rivals.

16. Existence Of Price Rigidity

Since firms in oligopoly markets depend on the pricing decisions of other companies, prices often stay steady.

This is known as price rigidity and it can lead to reduced competition in the market and higher prices for consumers.

17. No Unique Pattern Of Pricing Behaviour

In oligopolistic markets, the pricing strategies adopted by firms are not constrained to any one particular pattern.

This means that each firm has to take into account the pricing decisions of its rivals and adjust its own prices accordingly in order to remain competitive.

18. Indeterminateness Of Demand Curve

In oligopoly markets, due to the fact that firms are interdependent on each other’s pricing decisions, it is difficult to determine a unique demand curve for any given product or service. This means that firms have to rely on the pricing decisions of their rivals in order to set their own prices.

Overall, Characteristics of oligopoly markets include higher prices than perfect competition, more efficient production, advertising campaigns, group behavior among firms, barriers to entry of firms, lack of uniformity in pricing amongst competitors, and the existence of price rigidity.

Furthermore, these markets are characterized by no unique pattern of pricing behavior and the indeterminateness of the demand curve.

Types of Oligopoly

Pure Oligopoly: In a pure oligopoly, there are only two or three firms in the market that are not influenced by any other firm. This oligopoly environment is rife with fierce competition, as each business relentlessly fights to dominate the market.

Imperfect Oligopoly: In an imperfect oligopoly, there is more than one dominant firm but the market is still dominated by a few key players. In this type of oligopolistic market, companies work together to maximize their profits by fixing prices and engaging in less fierce competition.

Open Oligopoly: In an open oligopoly, there are many small firms in the market that can compete with each other but are not able to gain control over the entire market. This oligopoly is marked by price battles and strategic campaigns, as each company attempts to capitalize on the adversaries’ vulnerable spots.

Closed Oligopoly: In a closed oligopoly, there are few firms in the market and they have gained dominance over the entire industry. In this form of oligopoly, firms have secured a certain degree of market dominance, leading to an absence of competition.

Collusive Oligopoly: In a collusive oligopoly, firms form agreements to set prices and production levels in order to maximize their collective profits. Oligopolies of this nature are typified by both price stability and lucrative profits for all businesses involved.

Competitive Oligopoly: In a competitive oligopoly, there are few large firms but they compete aggressively with each other through pricing strategies, promotions, and advertising campaigns. This oligopoly structure is typified by fierce rivalry and prices that are considerably lower than those encountered in traditional or distorted oligopolies.

Partial Oligopoly: In a partial oligopoly, there are a few large firms that dominate the market but there are also many small firms that compete with each other. This oligopoly is defined by the intense rivalry among small firms and an incapability to control the entire market by any one firm.

Total Oligopoly: In a total oligopoly, only one firm has control over the entire industry and its pricing strategies govern the market. This type of oligopoly is known for its stable prices and exceptional returns to the primary business.

Organized Oligopoly: In an organized oligopoly, several large firms cooperate with each other in order to gain control over the entire market. This type of oligopoly is characterized by stable prices and increased profits for all participating firms.

Syndicated Oligopoly: In a syndicated oligopoly, several firms join together in order to gain control over the entire market. This type of oligopoly results in steady pricing increased profits for the firms involved, and a decrease in market competition.

Examples of Oligopoly

Motor Vehicles in the US: In the United States, motor vehicles are a prime example of an oligopoly. The US market is primarily dominated by three firms: General Motors , Ford , and Chrysler , which together account for approximately 70% of the total sales.

News Media: The news media industry is another example of an oligopoly, as there are only a few large media companies that control the entire market. These companies, such as NBC Universal, Disney , and Time Warner, are known for their immense power when it comes to influencing public opinion.

Breakfast Cereals: The breakfast cereals industry is an oligopoly in which only a handful of firms have significant control over the entire market. Companies like Kellogg’s, Quaker Oats, and General Mills dominate the global market for breakfast cereals.

Mobile Phones: The mobile phone industry is dominated by a few large players such as Apple , HTC , and Samsung . These companies have secured an overwhelming portion of the total market share, leaving only marginal room for new entrants or small businesses.

Beer: The beer industry is a prime example of an oligopoly, as it is dominated by only a few large firms. Companies like Anheuser-Busch InBev, MillerCoors, and Heineken control more than 70% of the total market share in the United States.

Conclusion!

In the end, oligopoly industries have characteristics that make them distinct from other market structures. They work in a competitive market and require businesses to be savvy in order to stay competitive.

Oligopoly industries can be difficult to enter and exit, as the few firms in the market tend to hold significant market power. Market forces of demand and supply still apply, however firms are more likely to focus on strategic pricing decisions in order to maximize profits. The marginal revenue curve is an important concept to understand in oligopolies, as it can provide guidance on how much revenue a firm will gain from a given price.

Understanding the oligopoly characteristics will give businesses an edge in making strategic decisions and staying competitive in their markets. In a world of intense competition, businesses in these industries must be prepared to adapt quickly in order to remain successful.

Liked this post? Check out the complete series on Marketing

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• Internal Customers – Definition, Examples and Characteristics
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• Secondary Data – Characteristics, Advantages and Examples
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What Makes a Market an Oligopoly?

Do you know of any industries in which just three or four companies supply most of a specific product?

Some examples:

• From the 1950s to the 1980s, three major broadcast television networks dominated the U.S. airwaves.
• After a series of mergers between 2005 and 2015, four major airlines controlled much of the U.S. market, as a November 2018 Page One Economics essay described.
• Even more recently, shortages and price increases brought attention to the U.S. baby formula market and global insulin market, which also had just a few suppliers.

Those markets could be considered “oligopolies”—markets in which only a few sellers or suppliers dominate.

Suppliers and sellers in an oligopoly can command higher prices than companies in a competitive market, and if one company in an oligopoly stops producing, it has a bigger effect on supply than it would in a competitive market.

Read on for more comparisons of oligopolies to other types of markets and to learn how to tell whether a particular market could be considered an oligopoly.

What Is an Oligopoly?

As the table shows, in addition to having only a few sellers or suppliers dominating the market, an oligopoly has barriers to entering the market, and “there are few close substitutes for the product.”

In other words, certain conditions make it difficult for potential competitors to start selling or supplying a particular product or service within that industry, and there aren’t many alternatives that could be used instead. Monopolies—markets in which one firm dominates—also have those barriers.

“Barriers to entry” could include factors such as costly equipment needed to produce a product, patents restricting who can use an invention, and government regulations that are difficult to meet, as a Corporate Finance Institute article outlined.

What Are Examples of Barriers to Entry?

In the case of the U.S. infant formula market, barriers to entry have included tariffs and Food and Drug Administration standards . (Some of the infant formula market barriers were waived to help ease the shortage last year.)

Until the expansion of the cable TV market in the 1980s, the limited availability of broadcast frequencies helped to restrict the number of television networks, with the Federal Communications Commission in charge of allocating portions of the broadcast spectrum to stations.

Barriers to entry in the airline industry include high startup costs, such as for purchasing airplanes, competition for airport gates and large economies of scale, the Page One Economics essay said.

Government can put up barriers, as a St. Louis Fed Econ Lowdown lesson on market structures (PDF)  outlined in discussing monopolistic markets. Such markets are rare, according to the lesson.

“Most commonly, [monopolistic markets] occur because government has granted a single firm the opportunity to supply a good or service. This is known as a ‘natural monopoly, ’ ” according to the lesson, which gives the examples of electric and natural gas providers. Because of the expensive infrastructure needed for those services, such as wires and pipes entering people’s homes, it’s cheaper for one firm to provide the service than to build infrastructure needed for true competition.

“In exchange, government often regulates prices in these markets to ensure that these firms do not take advantage of their market power,” the lesson says.

How Can You Tell If a Market Is an Oligopoly?

A “concentration ratio” is one tool that can indicate whether a market is an oligopoly.

A concentration ratio is the combined market share of the largest firms in an industry, according to Oxford Reference . That is, it’s the percentage of the industry’s products or services provided by those firms.

The number of firms used for the ratio can vary. A “four-firm” ratio is often used as a benchmark to show market structure, according to Oxford. But the ratios also can be calculated using the market share from the eight, five or three largest firms in the market, according to a September 2020 Investopedia article.

“A rule of thumb is that an oligopoly exists when the top five firms in the market account for more than 60% of total market sales,” the article says. “If the concentration ratio of one company is equal to 100%, this indicates that the industry is a monopoly.”

In 2015, the four major airlines controlled 80% of the U.S. market, the Page One Economics essay said. Three manufacturers have more than 90% of the global insulin market , according to a July 2022 press release from Grand View Research, a global market research and consulting company. That would make those markets oligopolies, according to the Investopedia rule of thumb.

What Are Two Types of Oligopolistic Markets?

Oligopolistic markets differ, and different types of markets have different effects on prices, as the Econ Lowdown lesson illustrates.

One such market is a collusive oligopoly , which has a few sellers who work together “to divide the market, set prices, or limit production,” the lesson says. Companies might, for example, agree to limit production to drive up prices. Such collusion is often illegal.

In a competitive oligopoly , the few sellers compete, which keeps the prices lower than they would be in a collusive oligopoly.

In general, more competition results in lower prices for consumers. So, a perfect competition market structure, in which lots of companies provide the same product, would result in lower prices, while a monopoly could mean the highest prices for consumers. Depending on whether they are collusive or competitive, oligopolies can be more like monopolies or more like perfect competition, respectively, as a Khan Academy video explains.

Can Oligopolies Change?

Market structures aren’t necessarily fixed, as the Page One Economics essay illustrated with the example of U.S. airlines.

Airline ticket prices declined as low-cost carriers started expanding their routes in 2016, the essay said. A chart from online database FRED shows the downward trend in airfares before the COVID-19 pandemic.

“The proliferation of low-cost flights in recent years has pushed the airline industry, which was arguably an oligopoly, toward monopolistic competition,” the essay said.

Heather Hennerich is a senior editor with the St. Louis Fed External Engagement and Corporate Communications Division.

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This blog explains everyday economics, consumer topics and the Fed. It also spotlights the people and programs that make the St. Louis Fed central to America’s economy. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.

Media questions

All other blog-related questions

An oligopoly is a market in which a few firms dominate, and an oligopolist is one of these dominant firms. While 'a few' is an imprecise number, economists generally look at the market shares of the top three, four or five firms - if these firms control most of the market, then the firms are oligopolists.

How is the degree of oligopoly measured?

Concentration ratios.

Concentration ratios (or CRs) can be used to help identify whether the firm operates under conditions of oligopoly. Concentration refers to the extent to which market power is in the hands of a small number of firms. Concentration ratios show the combined market shares of the top few firms as a ratio of the total market size, expressed as a percentage.

When markets are highly concentrated the conduct of firms and their efficiency is likely to be sub-optimal. [Read more on market structure and conduct .]

For example, the global music shares of the top producers are:

Universal Music, 31% Sony Music, 21% Warner Music, 18% Independents, 27% Artists Direct, 3% Source: MIDIA (2019),

This makes the three-firm CR 70% - indicating oligopoly conditions.

The H-H Index

he Herfindahl–Hirschman Index (HH-Index) is an alternative measure of market concentration in an industry. It is calculated by adding the squared market shares of the top few firms in a market. The higher the number, the greater the degree of concentration.

The maximum figure possible is for a single monopolist, which is 100 (%) x 100 (%) = 10,000 .

For example, let's assume that the market shares of the largest three firms in a hypothetical market are: Firm A = 35%, Firm B = 25%, and Firm C = 20%.

The H-H Index would give 35 2 + 30 2 + 25 2 , which equals:

1,225 + 625 + 400 = 2350 .

Example - UK Supermarkets

The top four UK supermarkets in 2022 by market share were Tesco, with 26.9%, Sainsbury, with 14.6%, ASDA with 14.1%, and Morrisons, with 9.1%. 

The H-H Index for the top four supermarkets in the UK in 2022 was 1222.

Generally, an H-H Index of more than 1200 indicates a high degree of concentration and suggests the market is an oligopoly.

Read more: Changing concentration in the UK electricity market

Key characteristics and features of oligopoly

Firms are interdependent.

As there are only a few other competitors in the market, the profit available to a single oligopolist is constrained by the actions and decisions taken by the other firms in the market.

For example, if one oligopolist - firm A - decides to reduce its price in the hope of gaining market share, and the two other firms in the market - B and C - also reduce their prices in response, firm A's strategy will have been thwarted.  An oligopolist needs to anticipate and respond to the actions and behaviour of rivals. The need to take rivals into account when making decisions is referred to as mutual interdependence .

Uncertainty

Given the importance of interdependence, oligopolists face high levels of uncertainty, perhaps never being able to fully predict the behaviour of close rivals. This explains the temptation to reduce competition and the attempt to co-operate with close rivals to reduce uncertainty.

The importance of strategy

As a result of interdependence, oligopolists must try to anticipate the likely response of rivals to any change in policy concerning price or to non-price decisions. Non-price decisions include decisions about the product itself, how it is distributed, how it is marketed and advertised.

Strategy is especially important for oligopolies that cannot easily differentiate their good or service, such as petrol retailers. If they can differentiate, they become less interdependent and more able to act independently.

Differentiated or undifferentiated?

Oligopolists may operate in markets where differentiation is difficult - such as the market for refined white sugar, or where differentiation is much easier - such as oligopolists in the motor manufacturing industry.

Competition or collusion?

It follows that a key feature of oligopolies is that key decisions must be made about whether firms actively compete with each other, or whether they limit competition. Competition can be reduced when firms collude with each other and act jointly to enable all firms to reduce uncertainty and increase the level of profits (or other benefits) available to the 'group' of firms.

Types of collusion

Oligopolists can engage in overt (open) collusion by establishing an agreement to reduce competition or to collaborate in some way. For example, members of cartels may create agreements to fix output or price, or other aspects of the market. While 'overt' collusion to fix prices is clearly anti-competitive, and therefore unlawful in most countries, other forms of collusion may be hidden and difficult to legislate for, and to police.

Covert collusion arises when oligopolists conspire to 'rig' a market by having agreements which are hidden and secret. In some cases, members may 'whistle-blow' in the hope that they may avoid any punishment if the collusion is discovered by the relevant competition authority. This is more likely if authorities offer incentives to whistle-blow.

Tacit collusion arises when firms appear to adopt a similar policy on price or non-price aspects of their business, but there is no agreement between them. This may not involve any collusion in the legal sense, and need not involve communication between firms. However, the outcomes (such as higher prices or reduced output) may well resemble those that arise from explicit collusion.

Tacit collusion may arise when firms follow rules which are understood rather than written down. For example, in an oligopoly market with three firms, it may be understood that firm A takes the lead in making a change to price, or to a non-price activity, and firms B and C simply follow the lead. This arrangement is not written and there may be no conscious attempt to rig the market. Price leadership is arguably the commonest form of tacit collusion - in this case, there is no conspiracy to act unlawfully.

From a legal perspective, anti-trust law is concerned with the process of collusion, rather than the outcome, and there must be a conscious commitment to achieve an unlawful outcome.

Types of competition

Oligopolists may prefer to compete, rather than collude, especially if the penalties for anti-competitive behaviour are significant (such as fines, being forced to wind-up, or loss of reputation if discovered.)

Competition can either involve competing on price - price competition - or competing in non-price ways - non-price competition .

For the oligopolist, price competition is risky as it can lead to retaliation, and to a price-war which can lead to falling profits for all firms in the industry. This explains the preference for non-price competition . For example, rather than compete on the price of their core product (petrol/'gas'), petrol retailers may compete through special promotions, through advertising, and by developing a respected brand.

Pricing strategies can also be introduced that reduce competition, such as cost-plus pricing . Cost-plus pricing exists when the oligopolist sets a selling price as a fixed mark-up above average production costs.

For example, insurance companies may set a fixed 20% mark-up above all their costs, including all the predicted claims costs. If all insurance companies share similar costs, then any sudden change in costs - such as following a particularly harsh winter, will result in all insurance companies raising their prices (called premiums) by the same or a very similar amount.

Barriers to entry

Oligopolists can maintain their relative dominance by benefitting from barriers to entry. These include expenditure on advertising and the strength of the brand in deterring entry; the benefit of economies of scale ; collusion between oligopolists; and pricing strategies to deter entry, such as limit pricing - setting a low price to limit the entry of new firms.

Read more on barriers to entry

Price-stickiness - the oligopolists kinked-demand curve

Prices in oligopolistic markets tend to 'stick' - often for lengthy periods - even when market conditions change. This can be explained though the kinked-demand curve .

The oligopolist faces two demand scenarios:

Firstly, when demand is elastic following a price rise , and secondly when demand is inelastic in response to a price drop .

In both scenarios, the firm is worse off - at least in terms of revenue. Raising price creates an elastic reaction, and lowering price creates an inelastic reaction. In both case, revenue is less than achieved at the original price.

Profits will also be maximised at the original price

Profit maximisation occurs where marginal cost (MC) cuts marginal revenue (MR). For the oligopolist, this may occur in the vertical section of the MR curve, between A and B. The level of profit depends upon the position of the ATC curve.

Once price is set, the kinked demand curve implies that the price sticks at P.

Even when we factor in the possibility of cost changes, the price will stick at its original level. Changes in costs have no effect at all if MC remains between A and B (the discontinuous portion of the oligopolist's MR curve). Even when MC moves outside of this range, price hardly changes.

Price stickiness and interdependence can also be explained through Game Theory .

Integration

Oligopolists tend to emerge over time through integration with other firms.

Integration can either be horizontal - between firms at the same stage of production (such as two airlines merging) - or vertical, which involves the integration of firms from different stages in production.

Vertical integration can be in one of two directions - backward, where one firm integrates with a firm which is nearer to the source of supply (such as a TV company purchasing a soccer team) or forward, which is where a producer integrates with a firm nearer to the final consumer (such as a farmer acquiring a grocery store.)

Numerical example

Why the oligopolist's demand curve is 'kinked' is a question that can be appreciated by considering a cost-revenue schedule.

Here we can see that the firm's average revenue curve falls with quantity, but because there are two different reactions to price - elastic for a rise, and inelastic for a fall - there is a kink in the demand (AR) curve and the MR curve will have a discontinuous portion (between output 6 and 7, as highlighted in the schedule).

The elastic response to the price rise results from rivals not changing their price in response, whereas the inelastic response to a price drop results in rivals being forced to 'follow suit' given that rivals would experience a considerable fall in market share if they did not reduce price.

If we transfer the figures to a graph we arrive at the classic kinked demand curve. Profits are maximised at output 6 (and price 75), which is where marginal cost (MC) equals marginal revenue (MR).

The area for super-normal profits is also highlighted.

• > Economics

What is Oligopoly: Types, Characteristics and Examples

• Pragya Soni
• Dec 18, 2021

Though, the British ruled period was a time of monopoly trade. But today, when globalization is at its peak, oligopoly is emerging as the leading market strategy. While the governments of a few countries are promoting it, others are banning it. 

Now the question arises, what is oligopoly in real life? How to identify it from monopoly? And if it is stable for the market or not. In this blog we will answer all your questions. We will read about the definition of an oligopoly market, its characteristics and consider a few real-life examples.

(Learn about Experimental economics )

What is the meaning of Oligopoly ?

The term oligopoly is basically related to economics and the market. It is a market controlling term. It may be defined as a market situation in which only a few producers affect the market. 

But that doesn’t mean they entirely control the market. The price change of each producer affects the actions of other producers. For instance, a reduction in the price of one producer may lead to an equal deduction by the other producers. 

This practice helps in retaining the same earlier share of the market but at lower profits. In oligopolistic industries the process is generally a blend of monopolistic and competitive tendencies. Oligopolies can be followed in several industries such as steel, aluminum and automobile industries.

In other words, oligopoly is defined as the market strategy that consists of several small numbers of firms. These firms or producers work explicitly to restrict output and thus control the market returns.

(Check out - What is Capital in Economics )

Types of oligopoly

Oligopoly market industries or oligopolistic strategies are classified into following types:

Pure oligopoly

Pure oligopoly is also known as perfect oligopoly. This strategy has a homogeneous product. For example, the aluminum industry.

Imperfect oligopoly  

Imperfect oligopoly is also known as differentiated oligopoly. This industry has product differentiation at the end. For example, the talcum industry.

Open oligopoly

Open oligopoly refers to the market strategy where the new industries can enter in the market and can compete with the existing industries.

Closed oligopoly

Closed oligopoly is the opposite of open oligopoly. Here the entry of new or other industries into the market is strictly banned.

Collusive oligopoly

Collusive oligopoly is basically a cooperative market strategy. It occurs when few firms collaborate to an understanding in reference to the price and results of the products.

Competitive oligopoly  

Competitive oligopoly is the opposite of collusive oligopoly and basically a competitive strategy. This type of oligopoly occurs due to lack of understanding between the industries of the market. Due to which they create invariable competition for one another.

Partial oligopoly  

In this strategy there exists an industry as the price leader. The situation when a particular firm or industry is more powerful in the market as compared to other industries. A large firm basically dominates the entire market.

Total oligopoly  

Total oligopoly is also known as partial oligopoly. It is the opposite of partial oligopoly and no particular industry or firm dominates the market. There is no price leadership in the market.

Organized oligopoly

As the name suggests this is an organized structure of oligopoly. In this strategy, an association is formed to fix prices, quotas, and output.

Syndicated oligopoly

Syndicated oligopoly is the opposite of organized oligopoly. In this strategy the industries are allowed to sell their product through a centralized syndicate.

(Read, Difference between macro and microeconomics )

What are the characteristics of oligopoly ?

Characteristics of oligopoly

The characteristics of an oligopoly market or oligopolistic strategy are mentioned below:

Interdependence

As in an oligopoly market, the decision of one firm influences the process and working of another firm. Thus, it induces interdependence in the network. It is the most important feature of an oligopolistic market. As this affects the prices and output of the market. A small change in a small firm has a direct impact on its rivals.

In order to match the impacts induced, the competitor firms might change their prices and profits. Thus, the oligopoly market is a totally interdependent network.

Advertising

Advertising is the key characteristic of the oligopolistic market. The firms are supposed to employ aggressive market techniques to defend the competition in the market. Due to interdependence, it is essential for the forms to invest a huge amount in the marketing and promotional activities. Thus, advertising has a great importance in an oligopoly strategy. 

Variable selling price

An oligopolistic market is a factor driven market and has interdependence on various factors. Thus, the selling price of the products in this market is quite unstable and varies at different instances.

Group behavior

The process of oligopoly is a group behavior. It is designed in such a way that a single firm can execute selfish behavior or profit-maximizing behavior. If it does, it automatically goes against the fundamentals of an oligopolistic market.

Entry barriers

Generally, it is difficult to enter an oligopolistic market, even in an open oligopoly. As it has to compete as a small start-up industry with large and economically stable firms. Here the most common entry barriers that are observed are as follows:

Exclusive resource ownership

Patents and copyrights

High start-up cost

Government restrictions

Few leading firms

There are only a few firms that control the entire sales and process of the market. In other words, the large number of firms is quite small in an oligopolistic market.

Identical or differentiated products

Unlike, monopoly market, the oligopoly market produces both kinds of goods, that is identical products and different products.

(Suggested Read - What is Deflation? )

How is oligopoly different from monopoly ?

In the modern era, there exist different market strategies such as monopoly and duopoly. Monopoly market refers to a market having only one producer. Similarly, duopoly has two producers in the market.

While oligopoly is the market strategy that involves a number of producers in the market. The upper limit of the number of producers in oligopoly is not fixed. But generally, the number is maintained in such a way that the decision and action of one industry or producer must affect and influence the others.

(Check out - Recession vs Depression )

What are the major examples of oligopoly market strategy ?

Examples of Oligopoly

In the modern era oligopoly is the most common market practice. The major examples of oligopoly markets are as follows:

Pharmaceutical sector

The pharmaceutical market is the most leading global market. It not only leads in drug innovation but also acts as a drug price maker. The pharmaceutical sector is a real example of oligopoly. 

As the market is controlled by top firms such as Merck, Pfizer and Abbott. The entry for new firms in this sector is quite limited and restricted.  As the patents are being registered here, it creates a notebook of experience for the future. Also, it can produce both similar and different products.

Media sector

Media sector is also a kind of oligopoly industry. Comparing the case of India, almost 90% of this sector is captured by leaders such as, The Tribune, ABP news etc. the decision of one producer totally influences the decision of other firms. 

And, if we minutely observe, the sector shows group behavior as well. And not a particular producer has the lead. You can yourself check that the prime time for every channel is different. This sector also invests huge amounts in advertising.

Computer technology industry

This sector is a best example of oligopoly. The entire computer technology market is globally dominated by two leaders named Apple and Windows. Due to their economic growth across the globe, no other firm is trying to enter in this sector. 

No matter what computer you choose, the embedded technology will be one of these two only. Thus, this sector serves a perfect example for a closed oligopolistic market.

Automobile industry

Similarly, the automobile industry is also an example of oligopoly. Let us take the case of India, no doubt, there are several automobile industries. But a dozen of them rule the market. 

These include Hyundai, Maruti, etc. Automobile sector is an example of organized oligopoly. As the standards and prices here are maintained by a generated authority.

Other examples of oligopoly strategy include following industries:

The steel industry

The petroleum industry

The photographic equipment industry

The cereal industry

The wine and beer sector

The aircraft manufacturing sector

The beverage industry

The gold jewelry makers

(Difference between Positive and Normative economics )

The profits maximization of an oligopoly market is governed by the Kinked demand curve. Oligopoly industries are more stable over other market strategies as they work on collaboration. Thus, they are more beneficial in the era of economic competition. 

This strategy also avoids evil practices such as price-fixing. And identifies a price leader in the market, the other firms follow the price leader to maximize their benefits. The government must take essential efforts to expand the network of oligopolistic markets.

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Essay on Oligopoly and Collusion

Last updated 3 Feb 2019

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Here is what I feel is a superbly clear and well-structured essay answer to a question on the economic and social effects of collusion within an oligopoly.

Evaluate the view that collusion between firms in an oligopoly always works against consumer and society’s interests. Use game theory in your answer.

An oligopoly is where the industry or market is dominated by a few producers/firms with a high level of market concentration, where the component firms have a high level of interdependent decision making. Collusion can be tacit and/or explicit, and the aim of which is to achieve higher supernormal profits, with the firms as a whole achieving joint profit maximisation. Collusion between firms is harmful to consumers. This is because firms collude to raise prices, as mentioned earlier, resulting in the price level seen below. This reduces the consumer surplus available, reducing the welfare of individuals. This can often be highly regressive, if the impact of increased prices, such as with the Big Six Gas Suppliers, has a disproportionate impact on the less well off. Furthermore, because firms are working together, with internal quotas to divide up sales, there is less need to compete, resulting in less dynamic efficiency. This results in less innovation, and thus little improvement in the quality of products available to individuals. Indeed, the UK Competition and Markets Authority supports this claim, arguing that collusion can result in “reductions of output, efficiency, innovation and choice, all of which are harmful to consumers.” An example of this can be seen with Apple, who were sued by consumers for price-fixing with publishers to force consumers to over pay for e-books.

However, collusion between firms can often derive benefits for consumers. For instance, tacit collusion includes firms who monitor what other firms sell to ensure that they are matching the cheapest price in a geographical area, or who market that consumers are “never knowingly undersold” such as John Lewis. This is a case in which firms are technically engaging in tacit collusion, but which may also result in driving down of prices as firms seek to match improvements in cost efficiencies made by other firms. This is also true with products such as mobile phone contracts where it is easy to compare prices.

Collusion in an oligopoly can hugely benefit firms, which can have beneficial consequences for society. For instance, collusion between coffee growers allows small firms to push for fairer prices against more dominant monopsonistic corporations such as Starbucks. Furthermore, because these producer cooperatives like Fairtrade are often based overwhelmingly in less developed regions, this can also be useful in helping to alleviate extreme poverty. Furthermore, collusion allows for firms to lower the costs of competition, that can then be passed onto consumers. Because oligopolies exist in highly concentrated markets dominated by a few firms, there is often a huge degree of branding and differentiation that needs to take place in order for firms to stand out, e.g. with the UK retail banking industry with firms such as Barclays and HSBC. If all firms engage in marketing wars, there is no net societal benefit. However, if firms collude, they can reduce the need to fund these marketing wars, that can allow for cost savings to be passed onto consumers. Additionally, collusion allows for agreed upon industry standards, for instance with procedures in testing on humans in pharmaceutical research, which benefits both consumers and firms.

However, the extent to which this occurs depends on a few factors. Firstly, the vast majority of collusion that takes place isn’t that of poor farmers working together - oligopolies are more concentrated industries with very high barriers to entry, such as the Big Four Accountancy Firms, and pharmaceutical companies. Furthermore, the benefits that accrue from firms working together are dependent on those firms passing those cost savings onto consumers - however, if they are all explicitly colluding, they may decide to spend that money on share buy-back schemes and dividends, which may not benefit society at large. Indeed, in 2017, US firms spent more money on share buy-backs than they did on research and development. Lastly, the benefits from firms agreeing upon industry standards are likely to be very marginal given the government and regulatory bodies, such as the Financial Conduct Authority (FCA) tend to set industry standards centrally.

Conclusion:

In conclusion, the extent of the impact on consumers and firms depends fundamentally on how long the oligopoly is able to carry on collusion - we can analyse this through game theory. Assuming the following pay offs in a cartel such as OPEC, where states agree to collude to reduce production levels and benefit from a higher price:

If all firms cooperate, they will achieve £4bn revenue. However, if one firm decides to defect and to increase production while still gaining from higher prices, they will gain £5bn. The socially optimal equilibrium in this model (for firms) is to cooperate, because the total utility is greater than any other option. However, this is an unstable equilibrium: no matter what the other firm does, each agent is better off by defecting, resulting in a Nash equilibrium of Defect, Defect. Indeed, this model can be shown by how in October 2018, Iran accused Saudi Arabia and Russia of breaking OPEC’s agreement on cutting output. Thus, the effects of collusion are very much dependent on how long it is able to last.

Author: Cary Godsal (February 2019)

More resources available here on the topic of oligopoly

• Tacit Collusion
• Overt collusion
• Game Theory
• Nash Equilibrium

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Monopoly vs. Oligopoly: What's the Difference?

Monopoly vs. Oligopoly: An Overview

A monopoly and an oligopoly are market structures that exist when there is imperfect competition. A monopoly is when a single company produces goods with no close substitute, while an oligopoly is when a small number of relatively large companies produce similar, but slightly different goods. In both cases, significant barriers to entry prevent other enterprises from competing.

A market's geographical size can determine which structure exists. One company might control an industry in a particular area with no other alternatives, though a few similar companies operate elsewhere in the country. In this case, a company may be a monopoly in one region, but operate in an oligopoly market in a larger geographical area.

Key Takeaways

• A monopoly occurs when a single company that produces a product or service controls the market with no close substitute.
• In an oligopoly, two or more companies control the market, none of which can keep the others from having significant influence. 
• Anti-trust laws prevent companies from engaging in unreasonable restraint of trade and transacting mergers that lessen competition.  

A monopoly exists in areas where one company is the only or dominant force to sell a product or service in an industry . This gives the company enough power to keep competitors away from the marketplace. This could be due to high barriers to entry such as technology, steep capital requirements, government regulation, patents or high distribution costs.

Once a monopoly is established, lack of competition can lead the seller to charge high prices. Monopolies are price makers. This means they determine the cost at which their products are sold. These prices can be changed at any time. A monopoly also reduces available choices for buyers. The monopoly becomes a pure monopoly when there is absolutely no other substitute available.

Monopolies are allowed to exist when they benefit the consumer. In some cases, governments may step in and create the monopoly to provide specific services such as a railway, public transport or postal services. For example, the United States Postal Service enjoys a monopoly on first class mail and advertising mail, along with monopoly access to mailboxes.  

The United States Postal Service enjoys a monopoly on letter carrying and access to mailboxes that is protected by the Constitution.  

In an oligopoly, a group of companies (usually two or more) controls the market. However, no single company can keep the others from wielding significant influence over the industry, and they each may sell products that are slightly different.

Prices in this market are moderate because of the presence of competition. When one company sets a price, others will respond in fashion to remain competitive. For example, if one company cuts prices, other players typically follow suit. Prices are usually higher in an oligopoly than they would be in perfect competition .

Because there is no dominant force in the industry, companies may be tempted to collude with one another rather than compete, which keeps non-established players from entering the market. This cooperation makes them operate as though they were a single company.

In 2012, the U.S. Department of Justice alleged that Apple ( AAPL ) and five book publishers had engaged in collusion and price fixing for e-books. The department alleged that Apple and the publishers conspired to raise the price for e-book downloads from $9.99 to $14.99.   A U.S. District Court sided with the government, a decision which was upheld on appeal.  

In a free market, price fixing—even without judicial intervention—is unsustainable. If one company undermines its competition, others are forced to quickly follow. Companies that lower prices to the point where they are not profitable are unable to remain in business for long. Because of this, members of oligopolies tend to compete in terms of image and quality rather than price.

Legalities of Monopolies vs. Oligopolies

Oligopolies and monopolies can operate unencumbered in the United States unless they violate anti-trust laws. These laws cover unreasonable restraint of trade; plainly harmful acts such as price fixing, dividing markets and bid rigging; and mergers and acquisitions (M&A) that substantially lessen competition.  

Without competition, companies have the power to fix prices and create product scarcity, which can lead to inferior products and services and higher costs for buyers. Anti-trust laws are in place to ensure a level playing field.

In 2017, the U.S. Department of Justice filed a civil antitrust suit to block AT&T's merger with Time Warner, arguing the acquisition would substantially lessen competition and lead to higher prices for television programming.   However, a U.S. District Court judge disagreed with the government's argument and approved the merger, a decision that was upheld on appeal.  

The government has several tools to fight monopolistic behavior. This includes the Sherman Antitrust Act , which prohibits unreasonable restraint of trade, and the Clayton Antitrust Act , which prohibits mergers that lessen competition and requires large companies that plan to merge to seek approval in advance.   Anti-trust laws do not sanction companies that achieve monopoly status via offering a better product or service, or though uncontrollable developments such as a key competitor leaving the market.

Examples of Monopolies and Oligopolies

A company with a new or innovative product or service enjoys a monopoly until competitors emerge. Sometimes these new products are protected by law. For example, pharmaceutical companies in the U.S. are granted 20 years of exclusivity on new drugs. This is necessary due to the time and capital required to develop and bring new drugs to market. Without this protected status, firms would not be able to realize a return on their investment , and potentially beneficial research would be stifled.

Gas and electric utilities are also granted monopolies. However, these utilities are heavily regulated by state public utility commissions. Rates are often controlled, along with any rate increases the company may pass onto consumers.

Oligopolies exist throughout the business world . A handful of companies control the market for mass media and entertainment. Some of the big names include The Walt Disney Company ( DIS ), ViacomCBS ( VIAC ) and Comcast ( CMCSA ). In the music business, Universal Music Group and Warner Music Group have a tight grip on the market.

Federal Trade Commission. " The Antitrust Laws ."

U.S. Government Accountability Office. " U.S. Postal Service: Key Considerations for Potential Changes to USPS's Monopolies ," Pages 3, 4.

U.S. Department of Justice. " Justice Department Reaches Settlement with Three of the Largest Book Publishers and Continues to Litigate Against Apple Inc. and Two Other Publishers to Restore Price Competition and Reduce E-book Prices ."

U.S. Court of Appeals for the Second Circuit. " United States v. Apple Inc. ," Pages 4-19.

U.S. Department of Justice. " Justice Department Challenges AT&T/DirecTV’s Acquisition of Time Warner ."

United States Court of Appeals for the District of Columbia Circuit. " United States of America v. AT&T, Inc. Et Al ," Pages 4-34.

U.S. Food and Drug Administration. " Frequently Asked Questions on Patents and Exclusivity ."

• Antitrust Laws: What They Are, How They Work, Major Examples 1 of 24
• Understanding Antitrust Laws 2 of 24
• Federal Trade Commission (FTC): What It Is and What It Does 3 of 24
• Clayton Antitrust Act of 1914: History, Amendments, Significance 4 of 24
• Sherman Antitrust Act: Definition, History, and What It Does 5 of 24
• Robinson-Patman Act Definition and Criticisms 6 of 24
• How and Why Companies Become Monopolies 7 of 24
• Discriminating Monopoly: Definition, How It Works, and Example 8 of 24
• What Is Price Discrimination, and How Does It Work? 9 of 24
• Predatory Pricing: Definition, Example, and Why It's Used 10 of 24
• Bid Rigging: Examples and FAQs About the Illegal Practice 11 of 24
• Price Maker: Overview, Examples, Laws Governing and FAQ 12 of 24
• What Is a Cartel? Definition, Examples, and Legality 13 of 24
• Monopolistic Markets: Characteristics, History, and Effects 14 of 24
• Monopolistic Competition: Definition, How it Works, Pros and Cons 15 of 24
• What Are the Characteristics of a Monopolistic Market? 16 of 24
• Monopolistic Market vs. Perfect Competition: What's the Difference? 17 of 24
• What are Some Examples of Monopolistic Markets? 18 of 24
• A History of U.S. Monopolies 19 of 24
• What Are the Most Famous Monopolies? 20 of 24
• Monopoly vs. Oligopoly: What's the Difference? 21 of 24
• Oligopoly: Meaning and Characteristics in a Market 22 of 24
• Duopoly: Definition in Economics, Types, and Examples 23 of 24
• Oligopolies: Some Current Examples 24 of 24

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What are the main characteristics of oligopoly?

Checked : Jessica S. , Ethan K.

Latest Update 26 Jan, 2024

Table of content

Benefits by firms in an oligopoly market

Differences with the monopoly market, significant characteristics of oligopoly market, interdependence:, team comportment:, concurrence:, business access barriers:, uniformity deficiency:, price rigidity existence:, no special pricing skill pattern:, the curve of market indeterminacy:.

Companies   in the oligopoly market   boost income much as companies in other markets. They optimize benefit in the number where an increasing marginal cost is equivalent to or approximates marginal income because the price is above the variable's average cost.

Regardless of how the demand curve is formed, one may assume that economic gains will be made feasible for oligopoly businesses in the long run since the business joined the market is more complicated. However, huge earnings are impossible in the long term.

If the selling price is so high, rivals can inevitably join, threaten current companies' costs, and reduce the business's profitability. Often fuel prices escalate, and there is outrage regarding the manipulation of customers by petroleum firms. Consumers will also react by lowering demand, while price levels are healthy. In the long term, these market mechanisms would reduce costs.

The monopoly rivalry condition is close. There is just one profit-maximizing corporation under monopoly. If you look at monopolies or a dynamic sector, a company's action usually is predictable. However, this is not feasible in oligopoly for many reasons:

The classes might not be formed by the corporations that form the community

A structured or informal association with negotiated codes of ethics can or cannot be formed by the group. A leader may control the company, but all businesses in the company can not universally obey it.

The interdependence of the different corporations in decision formation is the crucial trait of oligopoly. Both businesses in an oligopoly market accept this reality. If a small number of significant corporations form a company, one of which begins a wide-scale promotional initiative or introduces a revolutionary product paradigm that quickly steals the business, it is sure that the competing companies in the industry would cause countermoves.

With the oligopoly, a substantial policy shift on a corporation's part could impact other companies in the industry immediately. Therefore, competing businesses are continually responsive to the business's movements that assume action and adjusts policies. Publicity is thus a potent weapon in the oligopolistic’s possession.

To gain a significant portion of the business, a corporation under oligopoly will launch an intense marketing campaign. Most businesses in the sector would avoid aggressive ads.

A monopolist may find any ads lucrative when the product is fresh, or where many prospective buyers have never encountered their product earlier. In this sense, advertisement in the complete rivalry is pointless.

In an oligopoly, the action of the group is the most significant element. There may be two businesses in the company or 3 or 5 or even 15, but not just a few hundred. Regardless of how many, it is constrained, such that any organization understands that its decisions can affect other businesses in the community. In comparison, a vast number of businesses each aim to increase their earnings under optimal rivalry.

it adds to the presence of rivalry, another characteristic of the oligopoly industry. As several retailers are under oligopoly, a move by a seller would impact the competitors at once. Therefore, any seller is still vigilant and holds a close eye on the activities of his competitors to take revenge.

There are no hurdles to entry and departure from the market in an oligopoly sector. In the long term, though, there are some forms of penetration obstacles that appear to discourage new businesses from joining the market.

The absence of continuity in the number of businesses is another characteristic of the oligopoly industry. The composition of the businesses differs tremendously. Some may be little, some rather tall. This is an asymmetrical case, and in the American economy, this is quite popular. A universally large corporations' symmetrical condition is uncommon.

A corporation must hold to its price in an oligopoly environment. Should any corporation attempt to drop the price, the opposing competitors would repress with a higher price decrease. It adds to a trade fight that is not of interest to anyone. On the other side, as every corporation raises its costs to raise its revenues, the other competing businesses are not taking the same strategy. Therefore, no organization would want to slash or lift rates. Price stiffness can exist.

There are two opposing reasons for competition emerging out of the interdependence between the oligopolies. All need to be self-sufficient to get the full benefit. In this sense, they behave and respond in a way that is an ongoing aspect of volatility to the market production movements.

On the other side, each seller needs to negotiate with its rivals to reduce or remove the factor of confusion, which is driven again by benefit maximization. Both competitors consent tacitly or formally to adjust market results.

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A company’s demand curve is calculated in   business systems   rather than oligopolistic. However, the oligopolies' interdependence prohibits those sellers from creating a market curve even where the interdependence is well-defined. The market curve appears indefinite in actual business activities. Under oligopoly, a business may anticipate the other sellers to respond at least three separate occasions when their rates are reduced.

Some business organizations can retain their previous prices. In this scenario, an oligopolistic market may expect to increase its market significantly as rates decline. Other retailers then lower their prices by an equal number. And if the oligopolistic organization’s appetite for the first step rises as the costs fall, the rise itself is much smaller than in the first.

The other retailers cut their costs even further than a company lowers its rates. The oligopolistic company product demand, which takes the first phase, may decline under these circumstances. As a consequence of this complexity under oligopoly, the curve of demand encountered by each organization that belongs to the collective would be unavoidable.

References:

• https://www.toppr.com/guides/business-economics-cs/analysis-of-market/oligopoly/
• https://www.economicsdiscussion.net/oligopoly/top-9-characteristics-of-oligopoly-market/7342

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Home — Essay Samples — Business — Competition — Toyota Oligopoly

Toyota Oligopoly

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Words: 647 |

Published: Mar 19, 2024

Words: 647 | Page: 1 | 4 min read

Table of contents

Introduction, oligopoly market structure, competition and consumer welfare, innovation and r&d investment, government regulation and oligopoly.

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Economics Model Essay 11

(a)   Explain how the different characteristics of the market structures of monopolistic competition and oligopoly affect pricing and output decisions. [10] (b)   Discuss whether the behaviour of oligopolistic firms is consistent with the objective of profit maximisation. [15]

Introduction

(a)   Market structure refers to the characteristics of a market such as the number of firms, the nature of their products, the availability of knowledge and the extent of barriers to entry which affect the behaviour of the firms in the market. The market structures of monopolistic competition (MPC) and oligopoly differ in terms of the number of firms, the extent of barriers to entry and the presence or absence of strategic interdependence which affect pricing and output decisions.

A firm will maximise profit when it produces the output level where marginal cost (MC) is equal to marginal revenue (MR).

In the above diagram, profit is maximised at Q 0 where MC is equal to MR. If the firm increases output from Q 0 , both total revenue and total cost will rise. However, at an output level higher than Q 0 , such as Q 1 , MC is higher than MR. Therefore, the increase in total cost will be greater than the increase in total revenue and hence the increase in output will lead to a decrease in profit. If the firm decreases output from Q 0 , both total revenue and total cost will fall. However, at an output level lower than Q 0 , such as Q 2 , MR is higher than MC. Therefore, the decrease in total revenue will be greater than the decrease in total cost and hence the decrease in output will lead to a decrease in profit. Since profit cannot be increased by changing output from Q 0 , it must be maximised at Q 0 . The profit is represented by the shaded area, assuming the firm is making supernormal profit.

MPC and oligopoly differ in terms of the number of firms which affects pricing and output decisions. MPC is a market structure where there are a large number of small firms each with a small market share selling differentiated products that are close substitutes. An example of MPC is the restaurant market. Due to the large number of firms in the market and hence the large number of substitutes, the demand for the good of an MPC firm is likely to be price elastic. Therefore, an MPC firm has limited market power as it is able to charge a price only modestly higher than its marginal cost.

In the above diagram, due to the elastic demand which gives rise to the relatively flat demand curve (D), the price (P 0 ) is modestly higher than the marginal cost (MC 0 ). In contrast, oligopoly is a market structure where there are a small number of large firms each with a large market share generally selling differentiated products. An example of oligopoly is the pharmaceutical market. Due to the smaller number of firms in the market and hence the smaller number of substitutes, the demand for the good of an oligopolistc firm is less price elastic. Therefore, an oligopolistic firm has greater market power as the difference between price and marginal cost is greater compared to an MPC firm.

MPC and oligopoly differ in terms of the extent of barriers to entry which affects pricing and output decisions. In MPC, there are low barriers to entry which means that firms can make only normal profit in the long run. In other words, low barriers to entry in MPC preclude an MPC firm from charging a price higher than its average cost. If the firms in an MPC market are making supernormal profit, potential firms will enter the market in the long run due to the low barriers to entry. As the number of firms in the market increases, the market demand will be split among a larger number of firms and hence the demand for the good produced by each firm will decrease which will lead to a fall in the price and the quantity resulting in a fall in the profits of the firms. This process will continue until the firms in the market make only normal profit.

In the above diagram, the supernormal profit represented by the shaded area induces potential firms to enter the market in the long run which leads to a leftward shift in the demand curve of each firm (D) from D 0 to D 1 resulting in a fall in the price (P) from P 0 to P 1 and a fall in the quantity (Q) from Q 0 to Q 1 . At P 1 which is equal to average cost (AC 1 ), as the firms in the market make only normal profit, the incentive for potential firms to enter the market disappears. In contrast, there are high barriers to entry in oligopoly which means that firms can make supernormal profit in the long run. Although the supernormal profit will induce potential firms to enter the market, the high barriers to entry will prevent them from entering. In other words, high barriers to entry in oligopoly allow an oligopolistic firm to charge a price higher than its average cost in the long run.

MPC and oligopoly differ in terms of the presence or absence of strategic interdependence which affects pricing and output decisions. In oligopoly, due to the small number of large firms and hence the large market share of each firm, the actions of one firm affect and are affected by the actions of the other firms in the market, and this is commonly known as strategic interdependence. When an oligopolist changes its price, it will have a significant effect on the other firms in the market. The rival firms will hence react by changing their prices which will affect the first firm. Therefore, when an oligopolist makes pricing and output decisions, it must take into consideration the reactions of the other firms in the market. In this sense, the pricing and output decisions of an oligopolist depend on the behaviour of competitors. In contrast, MPC firms are not strategically interdependent. In MPC, due to the large number of small firms and hence the small market share of each firm, the actions of one firm do not affect and are not affected by the actions of the other firms in the market. Therefore, the pricing and output decisions of an MPC firm do not depend on the behaviour of competitors.

In conclusion, MPC and oligopoly have different characteristics which have implications for pricing and output decisions.

(b)   The question on whether the behaviour of oligopolistic firms is consistent with the objective of profit maximisation can be discussed with reference to the concepts of non-price competition, third-degree price discrimination, research and development, tacit collusion and alternative objectives of firms.

The behaviour of oligopolistic firms may be consistent with the objective of profit maximisation as they typically engage in non-price competition instead of price competition. The theory of the kinked demand curve explains price stability in oligopolistic markets where there is no collusion. The theory of the kinked demand curve is based on two asymmetrical assumptions. First, if a firm in an oligopolistic market increases its price, its rivals will not follow suit because by keeping their prices the same, they can attract consumers from the firm. Accordingly, if a firm in an oligopolistic market increases its price, its quantity demanded will decrease by a larger percentage as consumers will switch from the firm to the rivals which will lead to a fall in revenue for the firm. Second, if a firm in an oligopolistic market reduces its price, its rivals will follow suit to avoid losing consumers to the firm. Accordingly, if a firm in an oligopolistic market reduces its price, its quantity demanded will increase by a smaller percentage as consumers will not switch from the rivals to the firm, which will lead to a fall in revenue for the firm. Therefore, oligopolists do not have the incentive to change their prices, assuming no substantial changes in the cost of production. The theory of the kinked demand curve can be illustrated with a diagram. A firm in an oligopolistic market faces a demand curve that is kinked at the equilibrium and the kink on the demand curve leads to a discontinuity on the marginal revenue curve.

In the above diagram, as the price (P) and the output level (Q) are P 0 and Q 0 , the marginal cost (MC) curve must be cutting the marginal revenue (MR) curve at the discontinuity. A change in the cost of production will lead to a shift in the MC curve. However, as long as the MC curve lies between MC’ and MC”, the price will remain constant and this explains price stability in oligopolistic markets where there is no collusion. As the theory of the kinked demand curve explains price stability in oligopolistic markets where there is no collusion, it suggests that oligopolistic firms should engage in non-price competition instead of price competition. In reality, oligopolistic firms typically engage in non-price competition instead of price competition. For example, telecommunications companies in Singapore do not undercut one another. Instead, they engage in non-price competition through product development and product promotion.

The behaviour of oligopolistic firms may be consistent with the objective of profit maximisation as they practise third-degree price discrimination when the necessary conditions are met. Third-degree price discrimination is the practice of charging different prices for the same good in different markets. For example, cinema operators charge different prices for the same movies to different groups of consumers. To practise third-degree price discrimination, a firm which has price-setting ability must be able to identify at least two distinct markets which differ in terms of their price elasticities of demand. In addition, it must be able to prevent consumers in the lower-priced market from reselling the good to consumers in the higher-priced market which is known as arbitrage prevention. Suppose that a good is sold in two different markets, market A and market B, at two different prices. Under third-degree price discrimination, profit will be maximised when the marginal revenue in market A (MR A ), the marginal revenue in market B (MR B ) and the marginal cost (MC) are equal. If MR A is not equal to MR B , profit can be increased by selling less of the good in the market with the lower MR and more of the good in the market with the higher MR. If MC is not equal to MR A and MR B , profit can be increased by changing the output level. The firm will charge a higher price in the market with the lower price elasticity of demand and a lower price in the market with the higher price elasticity of demand. In reality, oligopolistic firms practise third-degree price discrimination when the necessary conditions are met. For example, the price elasticity of demand for cinema movies is lower for adults due to their higher level of income and hence smaller proportion of income spent on the good compared to students. Therefore, cinema operators in Singapore charge a higher price to adults and a lower price to students for the same movie on weekdays.

The behaviour of oligopolistic firms may be consistent with the objective of profit maximisation as they typically engage in research and development. Firms are likely to experience an increase in profit if they engage in research and development. Research and development will lead to product innovations and process innovations. Product innovations will lead to higher product quality and better product features which will lead to higher demand and lower price elasticity of demand resulting in higher total revenue. Process innovations will lead to a better production technology which will lead to higher labour productivity resulting in lower total variable cost. Although total fixed cost will rise due to the cost of research and development, the increase is likely to be more than offset by the rise in total revenue and the fall in total variable cost resulting in an increase in profit. In reality, oligopolistic firms typically engage in research and development. For example, smartphone producers as such Apple and Samsung constantly engage in research and development to improve the quality and the features of their products.

The behaviour of oligopolistic firms may not be consistent with the objective of profit maximisation due to tacit collusion in the form of dominant firm price leadership. In dominant firm price leadership, the dominant firm which is the firm with the largest market share is the price leader and the rest of the firms are the price followers. The price leader will set the price and the price followers will take the price set by the price leader. The price followers will also follow any price increase or decrease by the price leader. Typically, the price leader will set the price which maximises its profit. However, as the price leader will reap more economies of scale than the followers due to its large scale of production as a result of its larger market share, the price which will maximise the profit of the price leader will not maximise the profits of the price followers. The price followers will take the price set by the price leader due to the fear of a price war rather than to maximise profit.

The behaviour of oligopolistic firms may not be consistent with the objective of profit maximisation as they may be pursuing other objectives such as market share maximisation, sales revenue maximisation and long-run profit maximisation. For example, if a firm is a new entrant, it may want to maximise market share to compete with the incumbent firms. In this case, although profit will not be maximised, the larger market share may ensure the survival of the new entrant. For example, when StarHub entered the telecommunications market in Singapore in 2000, it charged prices lower than those charged by the incumbent firms, namely SingTel and M1. The objective of StarHub was to induce mobile phone users to switch mobile network service providers so that it could capture sufficient market share to compete with SingTel and M1. To maximise market share, a firm should produce the output level where price is equal to average cost, assuming it wants to make at least normal profit.

In the above diagram, market share is maximised at Q MS where price (P) is equal to average cost (AC), assuming the firm wants to make at least normal profit. Beyond this output level, price is lower than average cost and hence a loss will be incurred.

In the final analysis, it is important for an oligopolistic firm to pursue the objective of profit maximisation in the long run, if not in the short run. An oligopolistic firm that pursues the objective of market share maximisation or sales revenue maximisation instead of profit maximisation in the long run is unlikely to have the financial ability to expand its scale of production to reap more economies of scale. This is likely to put its long-term survival in jeopardy as it is likely to constrain its ability to increase its cost-competitiveness and hence price-competitiveness. Furthermore, an unprofitable oligopolistic firm is likely to have difficulty in raising funds at a favourable rate as financial institutions and investors are likely to consider the firm a high default risk. This is likely to further constrain its ability to increase its cost-competitiveness and hence price-competitiveness. However, unlike a private oligopolistic firm, the objective of a state-owned oligopolistic firm need not be profit maximisation. Indeed, for a state-owned oligopolistic firm that produces an essential good or service, such as healthcare, the objective should be to ensure the affordability of the good as high prices of essential goods and services are likely to cause hardship for the people, especially low income households. For a state-owned oligopolistic firm that produces a non-essential good and service, the objective should be to maximise the welfare of society as failure to do so will lead to a loss of social welfare. This can be done by producing the allocatively efficient output level where the marginal social benefit is equal to the marginal social cost.

The question will be discussed in economics tuition by the Principal Economics Tutor in greater detail.

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Economics Tuition Singapore @ Economics Cafe Principal Economics Tutor: Mr. Edmund Quek

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