Oligopoly

An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). The word is derived from the Greek for few (entities with the right to) sell. Because there are few participants in this type of market, each oligopolist is aware of the actions of the others. The decisions of one firm influence, and are influenced by the decisions of other firms. Strategic planning by oligopolists always involves taking into account the likely responses of the other market participants. This causes oligopolistic markets and industries to be at the highest risk for collusion.

Contents [hide] • • • • • •

1 Description 2 Demand curve 3 Oligopsonies 4 Examples 5 References 6 See also

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7 External links

[edit] Description Oligopoly is a common market form. As a quantitative description of oligopoly, the fourfirm concentration ratio is often utilized. This measure expresses the market share of the four largest firms in an industry as a percentage. Using this measure, an oligopoly is defined [by whom?] as a market in which the four-firm concentration ratio is above 40%.[citation needed]

Oligopolistic competition can give rise to a wide range of different outcomes. In some situations, the firms may collude to raise prices and restrict production in the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a cartel. Firms often collude in an attempt to stabilise unstable markets, so as to reduce the risks inherent in these markets for investment and product development. There are legal restrictions on such collusion in most countries. There does not have to be a formal agreement for collusion to take place (although for the act to be illegal there must be a real communication between companies) - for example, in some industries, there may be an acknowledged market leader which informally sets prices to which other producers respond, known as price leadership. In other situations, competition between sellers in an oligopoly can be fierce, with relatively low prices and high production. This could lead to an efficient outcome approaching perfect competition. The competition in an oligopoly can be greater than

when there are more firms in an industry if, for example, the firms were only regionally based and didn't compete directly with each other. The welfare analysis of oligopolies suffers, thus, from a sensitivity to the exact specifications used to define the market's structure. In particular, the level of deadweight loss is hard to measure. The study of product differentiation indicates oligopolies might also create excessive levels of differentiation in order to stifle competition. Oligopoly theory makes heavy use of game theory to model the behaviour of oligopolies: • • •

Stackelberg's duopoly. In this model the firms move sequentially (see Stackelberg competition). Cournot's duopoly. In this model the firms simultaneously choose quantities (see Cournot competition). Bertrand's oligopoly. In this model the firms simultaneously choose prices (see Bertrand competition).

[edit] Demand curve

Above the kink, demand is relatively elastic because all other firm’s prices remain unchanged. Below the kink, demand is relatively inelastic because all other firms will introduce a similar price cut, eventually leading to a price war. Therefore, the best option for the oligopolist is to produce at point E which is the equilibrium point and the kink point. In an oligopoly, firms operate under imperfect competition and a kinked demand curve which reflects inelasticity below market price and elasticity above market price, the product or service firms offer, are differentiated and barriers to entry are strong. Following from the fierce price competitiveness created by this sticky-upward demand curve, firms utilize non-price competition in order to accrue greater revenue and market share.

"Kinked" demand curves are similar to traditional demand curves, as they are downwardsloping. They are distinguished by a hypothesized convex bend with a discontinuity at the bend - the "kink." Therefore, the first derivative at that point is undefined and leads to a jump discontinuity in the marginal revenue curve. Classical economic theory assumes that a profit-maximizing producer with some market power (either due to oligopoly or monopolistic competition) will set marginal costs equal to marginal revenue. This idea can be envisioned graphically by the intersection of an upward-sloping marginal cost curve and a downward-sloping marginal revenue curve (because the more one sells, the lower the price must be, so the less a producer earns per unit). In classical theory, any change in the marginal cost structure (how much it costs to make each additional unit) or the marginal revenue structure (how much people will pay for each additional unit) will be immediately reflected in a new price and/or quantity sold of the item. This result does not occur if a "kink" exists. Because of this jump discontinuity in the marginal revenue curve, marginal costs could change without necessarily changing the price or quantity. The motivation behind this kink is the idea that in an oligopolistic or monopolistically competitive market, firms will not raise their prices because even a small price increase will lose many customers. This is because competitors will generally ignore price increases, with the hope of gaining a larger market share as a result of now having comparatively lower prices. However, even a large price decrease will gain only a few customers because such an action will begin a price war with other firms. The curve is therefore more price-elastic for price increases and less so for price decreases. Firms will often enter the industry in the long run.

[edit] Oligopsonies Oligopsony is a market form in which the number of buyers is small while the number of sellers in theory could be large. This typically happens in markets for inputs where a small number of firms are competing to obtain factors of production. This also involves strategic interactions but of a different nature than when competing in the output market to sell a final output. Oligopoly refers to the market for output while oligopsony refers to the market where these firms are the buyers and not sellers (eg. a factor market). A market with a few sellers (oligopoly) and a few buyers (oligopsony) is referred to as a bilateral oligopoly.

[edit] Examples In the United Kingdom, the four-firm concentration ratio of the supermarket industry is 74.4% (2006)[1]; the British brewing industry has a staggering 85% ratio. In the U.S.A., oligopolistic industries include the oil, beer, tobacco, accounting and audit services, aircraft, military equipment, and motor vehicle industries.

Many media industries today are essentially oligopolies. Six movie studios receive 90 percent of American film revenues, and four major music companies receive 80 percent of recording revenues. There are just six major book publishers, and the television industry was an oligopoly of three networks- ABC, CBS, and NBC-from the 1950s through the 1970s. Television has diversified since then, especially because of cable, but today it is still mostly an oligopoly (due to concentration of media ownership) of five companies: Disney/ABC, CBS Corporation, NBC Universal, Time Warner, and News Corporation.[2] In industrialized countries oligopolies are found in many sectors of the economy, such as cars, auditing, consumer goods, and steel production. Unprecedented levels of competition, fueled by increasing globalisation, have resulted in the emergence of oligopoly in many market sectors, such as the aerospace industry. Market shares in oligopoly are typically determined on the basis of product development and advertising. There are now only a small number of manufacturers of civil passenger aircraft, though Brazil (Embraer) and Canada (Bombardier) have fielded entries into the smaller-market passenger aircraft market sector. A further instance arises in a heavily regulated market such as wireless communications. In some cases states have licensed only two or three providers of cellular phone services. OPEC is another example of an oligopoly, although on the level of national bodies instead of corporate bodies. There are a few countries that try to control the production of oil. A further example are the 3 leading food processing companies, Kraft, PepsiCo and Nestle. Together these three corporations account for a large percentage of overall global processed food sales. These three companies are often used as an example of "The rule of 3"[3], which states that markets and industries often become dominated by three major oligopolistic firms. The city council of Arcata, California has passed a moratorium on marijuana dispensaries, grow facilities, and processing facilities. This moratorium freezes the ability to pass permits to open any of the above facilities. This has caused an oligopoly consisting of the three existing dispensaries not affected by this moratorium. The three dispensaries now have a government-enforced advantage. Australia has two very good examples of oligoplies. One is its media outlets, mostly owned by either News Corporation or Fairfax Media. Likewise, Australia's retailing industry is dominated by two companies, Coles-Myer and Woolworths.

Oligopoly Market Structure Advertise Here

Between the definitions of perfect competition and pure monopoly lie oligopolies and monopolistic competition. An oligopoly is where there are a few sellers with similar or identical products, such as hockey skates (Bauer, CCM). Monopolistic competition has

many companies with similar but not identical products. Each firm has monopoly power over what it produces, but products are close substitutes, such as cigarettes, CDs, and computer games. Examples of oligopolies include crude oil businesses and auto manufacturers. The main key to behaviour in an oligopoly, is that companies must take into account what other companies will do. In perfect competition, firms are price-takers and can ignore other firms. In a monopoly, there is only one firm, and it does not take into account what competitors will do. Oligopolists are torn between: 1. cooperating to increase profits by obtaining the monopoly outcome, or; 2. competing to try to gain an advantage over competitors.

Duopolies and Cartels A duopoly is when there are only two businesses in a market. Their best outcome is to cooperate and agree to restrict output to the monopoly quantity, where price is greater than margical cost, and profit is maximized. A great example of a duopoly is Coca-Cola and Pepsi Co. Usually, a duopoly trying to maximize profits will produce more than a monopolist but less than a competitive industry. Duopolies come from collusion where firms agree to share output and set prices such as in a cartel. A cartel is a group of companies acting in unison, such as OPEC. If the competing companies cannot agree, then they may end up with the competitive position with profits equal to zero. Cartels are known to restrict output quantities in order to raise prices, and consequently profits.

Size of an Oligopoly and the Market Outcome Generally, the more companies in the industry, the harder it is to form a cartel and to enforce it. As the number of companies increases, the more the industry resembles a competitive outcome, since each company has a smaller effect on the outcome. The mentality where each company tends to think only of its own profits and strategic behaviour is reduced. Each company will increase production as long as price is greater than marginal cost. As the number of companies increases, we tend to move towards a perfectly competitive outcome.

Game Theory and Prisoners' Dilemma Game theory is the study of how people behave in strategic situations (i.e. when they must consider the effect of other people’s responses to their own actions). In an oligopoly, each company knows that its profits depend on actions of other firms. This gives rise to the "prisoners’ dilemma".

The prisoners' dilemma is a particular game that illustrated why it is difficult to cooperate, even when it is in the best interest of both parties. Both players select their own dominant strategies for shortsighted personal gain. Eventually, they reach an equilibrium in which they are both worse off than they would have been, if they could both agree to select an alternative (non-dominant) strategy. I. Introduction A. An oligopoly market exists when barriers to entry result in a few mutually dependent companies controlling a substantial portion of a market. 1. Products may be homogeneous or differentiated. 2. Examples include many industrial products such as steel and large consumer durables such as appliances. 3. Automobile, steel, and other oligopolistic industries lost monopoly power because of the foreign invasion beginning in the 1970's. a. Eventually American companies became more competitive. b. The price was lower real wages for manufacturing workers. B Three well-defined pricing models exist 1. Kinked demand 2. Collusive pricing 3. Price leadership Please Blog Friends About This Free Library Using

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II. Kinked demand A. Describes a situation where a strong interdependency exists among firms within an industry B. A firm's demand curve tends to be elastic above equilibrium price as price increases are not followed by competitors. If they do follow, industry supply has changed. C. A firm's demand curve tends to be inelastic below equilibrium price as price decreases must be followed by competing firms. If competitors do not follow, a monopoly situation could be developing. D. This interdependency of pricing is studied with game theory models where participants react to possible pricing situations in a similar manner to the strategy of people playing chess or poker. E. Kinked Demand from Amos Web has a more complete explanation.

F. Profit model

G. Collusive pricing is when a formal agreement (cartel) or informal agreement among competitors to restrict supply and benefit from the resulting high price (OPEC).

III. Price leadership

A. One firm, usually dominant in size, sets price and others follow. B. The automobile industry with General Motors as the price leader was an example until foreign competition made the industry monopolistically competitive. Now the automobile industry is so competitive it is approaching the purely competitive model. C. Intel Corporation has tried with limited success to be a price leader in the computer chip industry.

IV. Restrictive vs. progressive oligopolies A. Restrictive oligopolies 1. A few companies share a market creating a near monopoly situation. 2. Example: Rust Belt industries in the United States before foreign competition. B. Progressive oligopolies 1. Technology lowers cost and improves product quality. 2. Companies must maintain technological base to survive.

3. Low consumer prices, high product quality, and monopoly profits exist simultaneously. 4. As long as new product development causes growth in consumer demand, funds are provided for R & D and capital investment requirements. 5. Examples include computer software and high-tech consumer electronics. V. Economic analysis of oligopoly A. Restrictive oligopolies tend to be very monopolistic in nature with 1. P > MR = MC 2. Production is not at the lowest point indicated by the ATC curve. 3. Economic profits exist and quantity is restricted. B. Progressive oligopolies have high economic profits in spite of price decreases brought on by high-tech efficiencies. VI. Desoligopolization is the disappearance of an oligopoly. (Material from Wikipedia) Oligopoly theory makes heavy use of game theory to model the behavior of oligopolies: • • • •

Stackelberg's duopoly. In this model the firms move sequentially (see Stackelberg competition). Cournot's duopoly. In this model the firms simultaneously choose quantities (see Cournot competition). Bertrand's oligopoly. In this model the firms simultaneously choose prices (see Bertrand competition). Monopolistic competition. A market structure in which several or many sellers each produce similar, but slightly differentiated products. Each producer can set its price and quantity without affecting the marketplace as a whole.