Oligopoly

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Oligopoly

Some industries are dominated by a few companies which are called concentrated markets. The domination that a firm has is determined by its concentration ratio.

Oligopoly in terms of market structure-

An Oligopoly is a market which is dominated by just a few firms, has high barriers to entry and firms in the market offer differentiated products.

An Oligopoly is a market where firms are interdependent and where the firms use competitive or collusive strategies to gain advantages from this interdependent strategy.

In order to maximise profits in a Oligopoly market, there s no single strategy that firms can adopt.

Competitive behaviour is a strategy olipolistic firms can adopt. Competiive behaviour is when various firms dont cooperate but compete with each other with an emphasis on prices. This type of behaviour is more likely to occur when one firms has lower costs than others, theres a relatively large number of big firms in the market,firms produce products which are very similar and the barriers to entry in a market are very low.

Collusive behaviour is when various firms cooperate with each other especially on what prices are charged. Formal collusion involves agreements between firms where they form a cartel. However, forming a cartel is illegal. Also, there is informal collusion which is tacit. This means that this collusion happens without an agreement and know its in their best interests to not compete with each other. In Oligopolistic markets some firms may act as price leaders which sets the trend for other firms to follow. This keeps price levels similar to each firm. Collusive behaviour is more likely to occur when all firms have similar costs, there are relatively few firms in the market , brand loyalty keeps customers buying from the same firms and barriers to entry are high.

Collusive Oligopolies have similar results as monopoly. This means that collusive oligopolies often lead to higher prices as well as restricted output. There is also allocative and productive inefficiency. The firms which are present in collusive oligopolies will often have the reosurces to invest into creating more efficient production methods. By improving the production methods this will cause dynamic efficiency. Nevertheless,firms in collusive oligopolies often lack incentive to invest in these new methods. This in turn can lead to market failure.

Even though some firms collude on prices, this doesn't stop them from competing in other ways, with marketing policies being significantly important. The firms in a colluding oligopoly may try to differentiate their products from other firms which can be done by improving the products in some way or try to create a strong brand to retain customers. Also, collusive oligopolies can use sales promotion to reward loyal customers. Another way a collusive oligopoly may compete will be through trying to find new export markets to export their products to.

If firms try to enter the collusive oligopoly, predatory pricing may take place.New firms may preserve until they can establish themselves.

An argument which some economists present is that collusive oligopolies aren't actually as bad as they are made out to be while also being unstable. The argument of these economists consist of the idea that formal collusions are actually unlikely to occur as they are usually illegal. Additionally, informal collusions are unlikely to last long as usually one firm will cheat which is called the first mover advantage. This entails one firm lowering their prices to gain an advantage and consequently usually starts a price war. As well as that, in collusive oligopolies if the firms aren't competing on price, non price competition will arguably be stronger. This could lead to dynamic efficiency, which is beneficial for consumers as it could led to product innovations and improvements. Also, firms in collusive oligopolies are unlikely to raise prices to extreme high levels as this would provide strong incentives for new entrants to join the market despite the high barriers to entry.

Competitive oligopolies can achieve high levels of efficiency as the firms are looking to lower their production cost as this means they can charge less to the consumer. This will mean the firm has achieved productive efficiency.

There are different types of collusion. There is overt collusion which is when there is no attempt to hide the agreement such as when firms form trade associations. Covert collusions are when firms try and hide the collusion to usually avoid being detected by regulators. Tacit collusion is when firms act together but there is no formal or informal collusion. Usually in tacit collusion it is accepted that one particular firm is a price leader. Therefore other firms follow this firm. This is just understood by the firms in the industry.

In the oligopolistic markets, all the firms are affected by each others behaviour making the firms interdependent. Behaviour in these particular markets can be looked on as a kind of mathematical game. This game is called the Game theory. The theory consists of analysing situations where two or more players are each trying to work out what to do to further their own interests. The fate of all players depends on their own decisions as well as the decisions of everyone else. This makes the players all interdependent.

The model of the kinked demand curve illustrates why prices in oligopoly markets are often relatively stable. The assumptions in Kinked Demand Curve are that if one firms raises its prices, the other firm won't raise theirs and if one firms lowers its price, the other firm will also lower theirs. The first assumption means that the firm which raises its prices will receive a large dip in demand. This is due to customers likely switching to buy goods from other firms. For example, when price is increase, demand becomes price elastic. As a result, the firm which raises their price will lose out as the fall in demand will cancel out the increase in price. Also, the latter assumption means that the firms which lower prices will fail to gain any market share. However, the overall size of the market may increase ever so slightly. When price is decreased, demand is inelastic. In total, any firm which reduces their prices will lost out as they won't gain market share but average price for good will fall.

The outcome shows that firms have no incentive to change prices as if they raise or lower prices, they will lose out as a result. Overall leads to price stability. Nevertheless, the kinked demand curve model only shows one type of interdependence. By this, it means that it doesn't explain the behaviour of firms in every oligopoly.

The prisoners dilemma model can be used to understand how interdependent firms might act in oligopolistic markets. For example, there are only two firms in the market. Each firm needs to decide what level of output to produce in their oligopolistic market. Each firm has two options; produce a high level of output or produce a low level of output. Both firms know that the other firm is trying to decide the level of output to produce, with both firms knowing that they're interdependent. The different choices which firms make can be shown using a payoff matrix. Firms can cooperate, making an agreement to restrict their output to low levels. From this both firms earn a profit of 200. However if both firms choose to have high levels of output, this will result in the firms both making a loss of 100. However, the best thing for a firm would be to stop cooperating and raise output after an agreement, but this needs to happen before other firm does it. If one firm cheats and raises outputs its in the interests of the other firm to keep producing at low outputs and take the profit of 100. This is because if it raises its output both firms will make a loss of 100. The first mover advantage can show why cartels are unstable.

On the contrary, being a first mover in an oligopoly market isn't always an advantage. It can depends on different situations, with different potential profits and losses that each firm could make in different scenarios. The firm who is the first mover can possibly over estimate the demand for the product and as a result make huge losses. Also, other competiting firms could use a lot of technology that the first firm developed. This would reduce the competitors costs and allow them to charge a lower price than first mover.

There are various advantages to oligopolistic markets. Firstly, an oligopoly may adopt an extremely competitive strategy. This competitive strategy will benefit the consumers as it will possibly make the firm lower their prices. Also,oligopolies may be dynamically efficient if they earn supernormal profits. This is because they may choose to re invest these supernormal profits. The price stability from competing oligopolies could possibly allow consumers to plan ahead and stabilise their expenditure.

There are various disadvantages to oligopolistic markets. For instance, high concentration in the oligopolistic markets reduces consumers choice. Also, in a collusive oligopoly, cartel behaviour between firms can reduce output while increasing price. Also, in collusive markets, there is high barriers to entry stopping firms entering the market. This maintains the lack of consumer choice.

Examples of Oligopoly markets include low cost airlines, burger market, broadband internet services, package holiday industry and newspapers.