Oligopoly

An Oligopoly Market is a system of Markets where there are more than one Vendor
(or firm) for trading of a particular good but there are very few Vendors. This is
imperfect competition as the decision of one Vendor affects the decision of others
in the Market, although the competition is very limited. The main characteristics of
this type of Market is the interdependence of the Vendors that urge them to
collaborate and compete with each other to control the Market, affecting the
demand and supply based on the prices.
Characteristics:

As mentioned above, the main characteristic feature of this type of Market is

interdependence of the firms. The other defining features of the Market are:

● Group behavior: To maintain the Market system, all the firms have to work
together.
● Restriction on entry: Entry in a tight knit Oligopoly Market is strictly
restricted, new firms trying to grow up or existing Vendors trying to expand
have to face serious competition.
● Emphasis on Advertisement: To get a bigger hold of the Market, each
Vendor tries to reach out more through advertisements.

Types of Oligopoly Market

Oligopoly Markets can be classified differently based on different factors affecting

the Market such as nature of the product, openness of the Market, degree of
collaboration between Vendors, functioning and structure of the Market, etc.
Nature of the Market:

1. Pure Oligopoly: The product in this type of Market is Homogenous, for

example, the Aluminium Industry.
 2. Differentiated Oligopoly: The products are differentiated in this type of
Oligopoly Market, for example, the Talcum Powder Industry.
Openness of the Market:

1. Open Market: Here, any new firm trying to enter the Oligopoly Market can
compete with the existing firms to establish a hold.
2. Closed Market: Entry is strictly restricted to new firms.
Collaboration between existing Vendors in the Market:

1. Collusive: The firms collaborate with each other and control the product
output and Market price for the product.
2. Competitive: In this type of Oligopoly, the Vendors do not co-operate with
each other and compete instead.
Functioning of firms:

1. Partial: When a firm takes a big hold of the Market and starts controlling
the prices, the other Vendors have to comply accordingly. This is a case of
partial Oligopoly Market.
2. Full: When there is no price controlling Vendor and every Vendor works
more or less the same way, it is full Oligopoly Market type.
Fixing of products price:

1. Syndicated Oligopoly: When only a very small group or an individual firm

controls the sale of products, it is a case of Syndicated Oligopoly.

2. Organized Oligopoly: When all the firms work together to fix output, sale,
prices, etcThe Market is called Organised Oligopoly Market.

Interestingly, the Oligopoly Market demand is marked by kinked demand curves.

Therefore, oligopolists maximize profits by balancing marginal revenue with the
marginal cost of the concerned product.

Examples:
● Telecommunications industry: The telecommunications skyline is
dominated by a handful of corporate behemoths—AT&T, Verizon
 Communications, and Sprint Corporation—that tower over the
business. These firms control most of the market share, resulting in
an oligopoly.
● Airline industry: The airline industry is marked by oligopolistic
competition, with a few large firms monopolizing the market. The
four largest U.S. carriers—United Airlines, American Airlines, Delta
Air Lines, and Southwest Airlines—control about 80 percent of
domestic air travel.
● Banking industry: The banking sector is one of the most
concentrated in the world, with just four banks, including JPMorgan
Chase, Citigroup, Bank of America, and Wells Fargo, controlling
nearly half of the market in the United States.
● Energy industry: In many countries, the energy industry is
dominated by a few companies. In the United States, for instance,
just three large firms—ExxonMobil, Chevron, and
ConocoPhillips—account for 70 percent of the oil and gas
production in the country.
● Automobile industry: The automobile industry is dominated by a
few large companies, such as General Motors, Ford Motor
Company, and Fiat Chrysler Automobiles, which together account
for more than 80 percent of the market share in the United States.
Parameters Oligopoly Monopoly

A market structure with a A market structure with only

Definition few large firms one large firm dominating the
dominating the industry industry

Number of
A few large firms One large firm
firms
Market power Significant market power Complete market power

Barriers to
High barriers to entry Very high barriers to entry
entry

Competition Limited competition No competition

Firms tend to engage in The monopolist has complete

Pricing price collusion and/or control over the price and
non-price competition quantity of goods or services

Firms may differentiate There is no close substitute for

Product
their products to some the monopolist’s product or
differentiation
extent service

Firms may invest in

The monopolist may have less
research and development
Innovation incentive to innovate since
to gain an edge over
there is no competition
competitors

Examples include Examples include the local

telecommunications, electric utility, the postal
Examples
airline, and automobile service, and some
industries pharmaceutical companies
Types Of Oligopoly

● Heterogenous oligopolies: In a heterogeneous model, companies

produce similar products, while consumers have a variety of options
(Dwivedi. 2016). An example of such an oligopoly is the automotive
industry. Machine manufacturers strive for differences in design,
specifications, and materials.
● Homogeneous oligopolies: Homogeneous oligopolists trade
products that do not differ in quality, attributes, and design. For
example, three major oil companies – BP, Shell, and ExxonMobil
dominate the world market in oil production (Dwivedi. 2016). Oil is
a commodity that is hard to differentiate – no matter the brand, it is
essentially the same commodity that you’re purchasing.

Homogeneous Oligopoly Heterogeneous Oligopoly

A market structure with a A market structure with a few

few large firms producing large firms producing and
Definition
and selling identical or very selling differentiated products
similar products or services or services

Products or services are

Product
Products or services are differentiated based on factors
differentiati
identical or very similar such as quality, design,
on
features, and branding
 Firms may engage in non-price
Firms tend to engage in
competition or use pricing
Pricing price collusion or follow the
strategies to differentiate their
market leader
products and gain market share

Firms compete on product

Firms compete mainly on
Competition differentiation, price, and other
price
non-price factors

Firms may have varying

Market Firms may have significant degrees of market power
power market power depending on the level of
product differentiation

Examples include the crude Examples include the soft drink

Examples oil industry, cement industry, industry, smartphone industry,
and steel industry and automobile industry

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.

Oligopoly Pricing Models

Depending on how market participants interact, economists distinguish four key

oligopoly models.

Here are main characteristics of oligopoly pricing models:

1. Leadership Model

As a rule, among the companies that have divided the market, one stands out and
occupies and maintains a dominant position (Dwivedi. 2016).

Usually, the leader is the first to make technological breakthroughs, set prices, and
dictate development direction to other market participants. After that, the rest of
the companies follow the leader, making the market look pretty consistent.

2. Cartel Model

This model is considered the best option for several oligopolists, allowing each to
get the maximum profit. Cartels allow companies to operate as if there is a
monopoly in the market. Together, they can prevent new players from entering the
market.

3. Bertrand Model
Even if the companies agree on the market, each has its own interests. To gain
market share, one company may start cutting prices. As a result, the other
companies will have to do the same.

So, some companies suffer losses and leave the market, as a result of which, over
time, there may be a single company with a monopoly position (Dwivedi. 2016).

4. Cournot Model

According to this model, each company tries to predict the state of the market to
develop an optimal work strategy. Companies take into account their own
production volumes, the expected reaction of competitors, and the price elasticity
of demand.

Depending on the model assumptions, companies can reach a stable equilibrium, or

the market can be constantly in flux (Dwivedi. 2016).

Cournot Model

The Cournot model was based on the economist Antoine Augustin Cournot’s
investigation of the duopoly in French spring water. In his model he assumes firms
produce a homogenous product, they do not co-operate, firms act rationally and
they have market power. The main form of competition is in choosing optimal
output.

Cournot concluded that firms would effectively act like a monopolist setting a
profit maximising output and price which gives no incentive to start a price war.
He argued the equilibrium in a duopoly is stable.

Bertrand Competition

Bertrand Competition. In the Bertrand model, Bertrand came to a different

conclusion – that in an oligopoly with a homogenous product the most likely
outcome would be the two firms setting price equal to marginal cost.
If a firm increased price above marginal cost, they would lose all market share to
the cheaper firm and would be forced to cut price until p=mc.

The model assumes no co-operation, homogenous product and no market power. It

also assumes firms can easily increase output and there are no capacity constraints.

Bertrand Competition

Definition of Bertrand Competition

A market structure where it is assumed that there are two firms, who both assume
the other firm will keep prices unchanged. Therefore, each firm has an incentive to
cut prices, but this actually leads to a price war. If products are perfect substitutes
this assumes the price will be driven down to marginal cost. This is allocatively
efficient (P=MC) but firms may not cover their fixed costs.

Bertrand Competition was developed by French mathematician Joseph Louis

François Bertrand (1822–1900) who investigated claims of the Cournot model in
Recherches sur les Principes Mathématiques de la Théorie des Richesses (1838)

The Cournot model argued that firms in duopoly would keep prices above marginal
cost and be quite profitable. Bertrand challenged this.

Assumptions of Bertrand Competiton

● No co-operation between firms and no attempt to collude and fix

higher prices
● A homogenous product which consumers are indifferent between.
● No search and transaction costs. Like perfect competition, it assumes
consumers have perfect information and if a good is 1% cheaper, then
consumers will buy
 ● Firms can easily increase output and there are no capacity constraints.
If a firm increases the price, the model assumes that all demand will
move to the cheaper firm. But, this requires supply to be perfectly
elastic and the firm to easily increase output in response to the surge
in demand.

Criticisms of Bertrand Competition

● It assumes firms do not learn from their mistakes. The initial

assumption is that the other firm will keep prices constant, but when
they see they also cut their price, they may change their behaviour.
● Firms in a duopoly should be able to make high profits. It depends on
the degree of barriers to entry.
● With two firms, there is a possibility of tacit collusion – or at least a
quiet industry which avoids a price war. Over time, there is the
possibility firms will learn from their behaviour and take a risk in
keeping prices above marginal cost.
● It depends on the objectives of firms, for example, is it to profit
maximise or increase market share. Bertrand Competition may be
more likely if they are seeking to maximise sales.
● Consumers are not just motivated by buying the cheapest good. Their
choices will reflect factors, such as brand loyalty, convenience, ease
of purchase and quality of the good.
● Firms will face capacity constraints and may not be able to increase
supply to meet the doubling of demand in a short time.
● Consumers may not have perfect information about the cheapest
goods.
● There may be search and transaction costs of moving to a cheaper
product.
● It is rare goods are homogenous, even with a good like water, firms
may have different brand images.
Imp Video links:

https://youtu.be/VUjbbplgODI

https://youtu.be/_yAFWgVj7Bg

https://youtu.be/U7sd2syRlLA

https://youtu.be/ZFoM0I6Tfkg

https://youtu.be/YGizpyniO3k