characteristics of oligopoly
There are a few firms selling a similar product.
There are barriers to entry.
Firms are interdependent, the actions of one firm will affect
the others in the industry.
An oligopoly is a market dominated by a few large
suppliers. The degree of market concentration is very high (i.e. a large
percentage of the market is taken up by the leading firms). Firms within an
oligopoly produce branded products (advertising and marketing is an important
feature of competition within such markets) and there are also barriers to
may take on a number of forms, depending upon the nature of the industry; this
allows firms to make abnormal profits in the long run.
between firms means that each firm must take into account the likely
reactions of other firms in the market when making pricing and investment
decisions. This creates uncertainty in such markets - which we seek to model
through the use of game theory.
Examples of oligopoly are the sale of petrol,
supermarkets, telecommunications, banks and building societies.
Theories About Oligopoly
There are four major
theories about oligopoly pricing:
- Oligopoly firms collaborate to charge the
monopoly price and get monopoly profits
- Oligopoly firms compete on price so that price
and profits will be the same as a competitive industry
- Oligopoly price and profits will be between
the monopoly and competitive ends of the scale
- Oligopoly prices and profits are
"indeterminate" because of the difficulties in modelling
interdependent price and output decisions
- When one firm has a dominant position in the
market the oligopoly may experience price leadership. The firms with lower
market shares may simply follow the pricing changes prompted by the
dominant firms. We see examples of this with the major mortgage lenders
and petrol retailers.
The Importance Of Price And
Firms compete for
market share and the demand from consumers in lots of ways. We make an
important distinction between price competition and non-price competition.
Price competition can involve discounting the price of a product (or a range of products)
to increase demand.
Non-price competition focuses on other strategies for increasing market share. Consider the
example of the highly competitive UK supermarket industry where non-price
competition has become very important in the battle for sales
- Mass media advertising and marketing
- Store Loyalty cards
- Banking and other Financial Services
(including travel insurance)
- In-store chemists / post offices / creches
- Home delivery systems
- Discounted petrol at hyper-markets
- Extension of opening hours (24 hour shopping
in many stores)
- Innovative use of technology for shoppers
including self-scanning machines
- Financial incentives to shop at off-peak times
- Internet shopping for customers
demand curve theory
developed in the late 1930s by the American Paul Sweezy. The theory aims to
explain the price rigidity that is often found in oligopolistic markets. It
assumes that if an oligopolist raises its price its rival will not follow
suit, as keeping their prices constant will lead to an increase in market
share. The firm that increased its price will find that revenue falls by a
proportionately large amount, making this part of the demand curve relatively
if an oligopolist lowers its price, its rivals will be forced to follow suit
to prevent a loss of market share. Lowering price will lead to a very small
change in revenue, making this part of the demand curve relatively inelastic
then has no incentive to change its price, as it will lead to a decrease
firm's revenue. This causes the demand curve to kink around the present
market price. Prices will further stabilize as the firm will absorb changes
in its costs as can be seen in the diagram below. The marginal revenue jumps
(vertical discontinuity) at the quantity where the demand curve kinks, the
marginal cost could change greatly - e.g., MC1 to MC2 (between prices a and
b)- and the profit maximizing level of output remains the same.