Oligopoly is when a few companies dominate a market. Sometimes they behave as if they were a monopoly. To do so, they usually form a cartel. One firm depends on the other firms. That's why the behaviour of oligopolies is really hard to predict. The evidence suggests that cartels are unstable. When oligopolies compete on price, they may produce as much and charge as little as they were in a market with perfect competition. Oligopoly is a market structure in which:
- natural or legal barriers prevent the entry of new firms
- a small number of firms compete
Barriers to entry
Oligopoly can be caused by natural or legal barriers to entry. A legal oligopoly arises when a legal barrier to entry protects the small number of companies in a market. We can distinguish two types of natural oligopolies:
- natural duopoly which is a specific type of oligopoly. It's an oligopoly with two firms. There is no place in this market for three firms. If there was only one company, it would make an economic profit and a second company would enter to gain some economic and business profit.
- natural oligopoly with three firms. One firm is not able to satisfy the market demand. There has to be more than one or two companies in order to satisfy the market demand at the lowest possible price.
Because barriers to entry exist, oligopoly consists of a small number of firms, each of which has a large share of the market. Such firms are independent and they face a temptation to cooperate to increase their joint economic profit.
Examples of oligopoly
Examples of oligopolies are the automobile, car rentals, tobacco companies etc. Because there are few sellers in an oligopoly, the market actions of each seller can have a strong effect on competitors' sales and prices. If General Motors, for example, reduces prices Ford, Toyota, Nissan usually do the same to retain their market shares. In the absence of much price competition, product differentiation becomes the major competitive weapon.
Traditional oligopoly models
There are two traditional oligopoly models:
First of them The Kinked Demand Curve Model is based on the assumption that each firm believes that if it raises its price, others will not follow but if it cuts its price, other firms will cut theirs. Second type of oligopoly models explains a dominant firm oligopoly, which arises when one firm has a big cost advantage over the other firms and produces a large part of the industry output. This firm is called the dominant firm. The dominant firm sets the market price and the other firms are price takers.
Advantages of Oligopoly
Oligopoly has some advantages. Firstly, oligopolies are often able to create economies of scale and benefit from increased efficiency. As a result, consumer prices may be lower than in markets with perfect competition. Additionally, oligopolies can use their market power to influence consumer behaviour and increase profits. Furthermore, due to the limited number of firms, oligopolies are able to create strong brand loyalty and often enjoy higher profits than in markets with perfect competition. Finally, oligopolies can use their market power to reduce competition and create barriers to entry.
Limitations of Oligopoly
Oligopoly is a market structure in which a few firms dominate the industry. It is characterized by a high degree of interdependence between the firms, as each firm is aware of the actions taken by its competitors. However, there are certain limitations to this market structure. These include:
- Limited Competition: Oligopolies tend to be less competitive and may result in higher prices for consumers. In addition, firms may collude to limit competition, leading to reduced consumer choice.
- High Barriers to Entry: Oligopolies can be difficult to penetrate due to high entry barriers such as high capital requirements, access to resources, and the advantages of existing firms.
- Non-Price Competition: Since firms cannot compete on price, they may resort to non-price competition such as advertising campaigns and product differentiation to gain a competitive advantage.
- Inefficient Allocation of Resources: Oligopolies may lead to inefficient allocations of resources, as firms have an incentive to produce too much of one product and too little of another, leading to market inefficiencies.
Oligopoly is a market structure in which a few companies dominate the market and can behave as if they were a monopoly. Other approaches related to Oligopoly include:
- Strategic pricing and non-price competition - This involves firms engaging in strategies such as price wars, advertising campaigns and product differentiation to gain an advantage.
- Collusion - This is when firms agree to raise prices and share markets. This type of agreement is usually illegal, but firms may still attempt to collude in order to gain more control over the market.
- Mergers - This is when two firms combine to form a single entity. This can be used to gain more control over the market.
- Barriers to entry - Oligopolies can use different tactics to make it difficult for new firms to enter the market.
In summary, oligopoly is a market structure in which a few companies dominate the market and can behave as if they were a monopoly. Other approaches related to oligopoly include strategic pricing and non-price competition, collusion, mergers and barriers to entry.
|Oligopoly — recommended articles|
|Monopoly — Price strategy to eliminate competitors — Fragmented market — Competition — Fair competition — Price war — Monopolistic agreement — Cartel — Free competition|
- Stigler, G. J. (1964). A theory of oligopoly. The Journal of Political Economy, 44-61.
Author: Beata Ciuba