Everything about Oligopoly totally explained
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
a few over many. 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.
Description
Oligopoly is a common market form. As a quantitative description of oligopoly, the
four-firm 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 as a market in which the four-firm concentration ratio is above 40%.
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's 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 doesn't 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:
Demand curve
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're downward-sloping. 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 doesn't 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 won't raise their prices because even a small price increase will lose many customers. 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.
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.
Examples
In the United Kingdom, the four-firm concentration ratio of the
supermarket industry is 74.4% (2006); 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's still mostly an oligopoly (due to
concentration of media ownership) of five companies:
Disney/ABC,
Viacom/CBS,
NBC Universal,
Time Warner, and
News Corporation.
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.
Arcata, CA, USA city council has passed a moratorium on Marijuana Dispenseries, grow facilities, and processing facilities. This moratorium freezes the ability to pass permits to open any of the above facilities. This has caused on oligopoly with the three existing Dispenseries which won't be affected by this moratorium. The three dispenseries now have a government enforced advantage.
Beat The Market is an economics game that simulates oligopoly and other market structures.
Further Information
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