Oligopoly

Wikipedia, the free encyclopedia - Cite This Source

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 sellers. 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 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).

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 are 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 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. 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 beer, tobacco, accounting and audit services, aircraft, military equipment, motor vehicle, film and music recording industries.

In industrialized countries oligopolies are found in many sectors of the economy, such as cars, 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.

Notes

External links

BasicEconomics.info - Oligopoly Market Structure
Microeconomics by Elmer G. Wiens: Online Interactive Models of Oligopoly, Differentiated Oligopoly, and Monopolistic Competition
Vives, X. (1999). Oligopoly pricing, MIT Press, Cambridge MA. (A comprehensive work on oligopoly theory)
Oligopoly Watch A blog on current oligopoly issues from a business and social perspective

Wikipedia, the free encyclopedia © 2001-2006 Wikipedia contributors (Disclaimer)
This article is licensed under the GNU Free Documentation License.
Last updated on Wednesday March 12, 2008 at 14:25:30 PDT (GMT -0700)
View this article at Wikipedia.org - Edit this article at Wikipedia.org - Donate to the Wikimedia Foundation