Oligopoly - Economics Help (2024)

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 areless than monopoly.
  • Differentiated products. In an oligopoly, firms often compete on non-price competition. This makesadvertising 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:

  1. Stable prices (e.g. through kinked demand curve) – firms concentrate on non-price competition.
  2. Price wars (competitive oligopoly)
  3. 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.

Price wars

Firms in an oligopoly may still be very competitive on price, especially if they are seeking to increase market share. In some circ*mstances, 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.

Collusion

  • 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.

Related

  • Pricing strategies
  • Diagrams for oligopoly
  • Game Theory
Oligopoly - Economics Help (2024)

FAQs

Do oligopolies help the economy? ›

The economic and legal concern is that an oligopoly can block new entrants, slow innovation, and increase prices, all of which harm consumers.

What are the characteristics of an oligopoly economics help? ›

An oligopoly exists when the market is dominated by a small number of firms. Key characteristics include high barrier to entry, small number of firms, similar product offerings, and pricing that is dictated by the firms involved.

What is the best strategy for an oligopoly? ›

Non-Price CompetitionDue to their concern over price wars in oligopolies, businesses strive to avoid price competition and instead rely on non-price strategies like marketing, after-sales services, assurances, etc. This guarantees that businesses can shape demand and increase brand recognition.

What is oligopoly in economics with an example? ›

Oligopoly is a form of imperfect competition and is usually described as the competition among a few. Hence, Oligopoly exists when there are two to ten sellers in a market selling hom*ogeneous or differentiated products. A good example of an Oligopoly is the cold drinks industry.

Who benefits from oligopoly? ›

Firms see more economic benefits in collaborating on a specific price than in trying to compete with their competitors. By controlling prices, oligopolies are able to raise their barriers to entry and protect themselves from new potential entrants into the market.

Are oligopolies good or bad for society? ›

Oligopolies exist naturally or can be supported by government forces as a means to better manage an industry. Customers can experience higher prices and inferior products because of oligopolies, but not to the extent they would through a monopoly, as oligopolies still experience competition.

Do oligopolies make normal profit? ›

Both producers and consumers can benefit from the oligopolistic market structure. The most important advantages of oligopoly include: Firms can gain extreme profits due to little to no competition in an oligopoly market structure, allowing them to charge higher prices and expand their margins.

How to increase profit in oligopoly? ›

Oligopolists earn their highest profits if they can band together as a cartel and act like a monopolist by reducing output and raising price. Since each member of the oligopoly can benefit individually from expanding output, such collusion often breaks down—especially since explicit collusion is illegal.

What are the pros and cons of oligopoly? ›

The advantages of an oligopoly include increased efficiency and innovation, while the disadvantages include limited competition and potential for collusion. The paper proposes a quantitative framework to analyze the advantages and disadvantages of oligopolies in concentrated industries.

Is Amazon a monopoly or oligopoly? ›

The FTC portrays Amazon as a monopoly by narrowing the relevant market to “online superstores.” That definition conveniently limits Amazon's competitors to Walmart and Target.

Why is Apple an oligopoly? ›

Apple Inc. is a trillion-dollar company and if we just talk about apple iPhones, IPad and iOS it can come under an oligopolistic market structure because there are only 3 main operating systems that are competitive namely iOS, owned by Apple Inc., Harmony os, owned by Huawei and Android, which is owned by Google and ...

Is Netflix an oligopoly? ›

The streaming industry is recognized for its oligopolistic nature, where key platforms hold considerable market power. Even as Netflix cements itself as the undisputed market leader, the trend is not towards a monopolistic market, but a more competitive one.

What are the advantages of oligopoly in an economy? ›

They include the following pros:
  • low level of competition;
  • high potential to receive big profits;
  • a great demand for products and services controlled through oligopolies;
  • a limited number of companies makes it easier for customers to compare and choose products;
  • more competitive prices;
Mar 22, 2023

Do oligopolies make economic profit in the long run? ›

Oligopolies are often buffeted by significant barriers to entry, which enable the oligopolists to earn sustained profits over long periods of time. Oligopolists also do not typically produce at the minimum of their average cost curves.

What are the disadvantages of oligopolies on the economy? ›

However, disadvantages include reduced competition, potential for collusion leading to higher prices, and barriers to entry for new firms.

How can oligopolies potentially benefit society? ›

How can oligopolies potentially benefit society? They can produce using economies of scale to lower average costs. The graph below shows the collusion model of oligopoly. What level of output corresponds to allocative efficiency in the market?

References

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