╸ oligopoly

oligos
polein

╸
Oligopoly
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 AIRCRAFT
MANUFACTURING OIL INDUSTRY
INDUSTRY
AUTOMOBILE
INDUSTRY

THE BEER
WHOLESALE
STEEL INDUSTRY INDUSTRY SOCIAL MEDIA
 • Under
Oligopoly,
there are a
few large
firms
although the
exact
number of
firms is
undefined.
• Also, there is severe
competition since
each firm produces a
• There are just significant portion of
several the total output.
sellers who
control all or
most of the
sales in the
industry.
 It is difficult to enter an
oligopoly industry and
compete as a small start-up
company. Oligopoly firms are
large and benefit from
economies of scale. It takes
Under Oligopoly, a considerable know-how and
firm can earn super- capital to compete in this
industry.
normal profits in the
long run as there are
barriers to entry like
patents, licenses,
control over crucial
raw materials, etc.
These barriers
prevent the entry of
new firms into
the industry.
 This ensures that firms can
influence demand and build
brand recognition.

Firms try to avoid

price competition due
to the fear of price
wars in Oligopoly
and hence depend
on non-price
methods
like advertising, after
sales services, warra
nties, etc.
 Oligopoly firms are large
relative to the market in For instance, if Pepsi
which they operate. If one lowers its price by 20 cents
oligopoly firm changes its per bottle, Coke will be
price or its marketing affected. If Coke does not
strategy, it will significantly respond, it will lose
impact the rival firm(s). significant market share.
Therefore, Coke will most
likely lower its price, too.
Under Oligopoly, since a few
firms hold a significant share
in the total output of the
industry, each firm is
affected by the price and
output decisions of rival
firms. Therefore, there is a
lot of interdependence
among firms in an oligopoly.
Hence, a firm takes into
account the action and
reaction of its competing
firms while determining its
price and output levels
Oligopoly firms
frequently advertise on
a national scale. Many
Super Bowl, World
Series, Wimbledon Under oligopoly,
finals, World Cup finals, the products of the
NBA finals, and NCAA
March Madness firms are either
advertisements are homogeneous or
sponsored by oligopoly
firm differentiated.
Since firms try to avoid
price competition and
there is a huge
interdependence • Under Oligopoly, firms want to
among firms, selling act independently and earn
costs are highly maximum profits on one hand
important for competing and cooperate with rivals to
remove uncertainty on the other
against rival firms for a hand.
larger market share. • Depending on their motives,
situations in real-life can vary
making predicting the pattern of
pricing behavior among firms
impossible. The firms can
compete or collude with other
firms which can lead to different
pricing situations.
Unlike other market
structures, under Oligopoly, it And on the other hand there
is not possible to determine is uncertainty regarding the
the demand curve of a firm. reaction of the rivals. The
This is because on one hand, rivals can react in different
there is a huge ways when a firm changes its
interdependence among price and that makes the
rivals. demand curve indeterminate
Table 1 – Demand for firm X’s product, if the rival firm does not copy a price change

Price Quantity Total Revenue Marginal

Revenue

10.50 0 0 –

10 1 10 10

9.50 2 19 9

9.00 3 27 8

8.50 4 34 7

8.00 5 40 6

7.50 6 45 5

7.00 7 49 4

6.50 8 52 3
Table 2 – Demand for firm X’s product, if the rival firm does copy a price change

Price Quantity Total Revenue Marginal

Revenue

13.00 0 0 –

12.00 1 12 12

11.00 2 22 10

10.00 3 30 8

9.00 4 36 6

8.00 5 40 4

7.00 6 42 2

6.00 7 42 0

5.00 8 40 -2
Oligopoly Average & Marginal Revenue

1. Total Revenue – Total Quantity x Price.

2. Marginal Revenue – the revenue earned by
selling one more unit.
3. Average Revenue – total revenue/quantity.
Since all the units are the same price, each new
unit would have the same average revenue, so
the marginal revenue = total revenue.
 Why do oligopolies exist?

1. 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.
This is quite important, as new firms may offer much lower prices
and thus jeopardize the longevity of the colluding firms’ profits.

2. In most markets, antitrust laws exist that aim to prevent price

collusion and protect consumers. Nonetheless, firms have devised
ways to achieve price collusion without being detected by
regulators. For example, firms might elect a price leader that is
tasked with leading changes in prices before other firms follow suit
in order to ―react to competition.‖ Firms may also agree to change
their prices on specific dates; in such cases, the changes may be
seen as merely a reaction to economic conditions such as
fluctuations in inflation.
- A combination of the barriers to entry that create monopolies and the product differentiation
that characterizes monopolistic competition can create the setting for an oligopoly. For example,
when a government grants a patent for an invention to one firm, it may create a monopoly. When
the government grants patents to, for example, three different pharmaceutical companies that
each has its own drug for reducing high blood pressure, those three firms may become an
oligopoly.
- A natural monopoly will arise when the quantity demanded in a market is only large enough
for a single firm to operate at the minimum of the long-run average cost curve. In such a setting,
the market has room for only one firm, because no smaller firm can operate at a low enough
average cost to compete, and no larger firm could sell what it produced given the quantity
demanded in the market.
- Quantity demanded in the market may also be two or three times the quantity needed to
produce at the minimum of the average cost curve—which means that the market would have
room for only two or three oligopoly firms (and they need not produce differentiated products).
Again, smaller firms would have higher average costs and be unable to compete, while additional
large firms would produce such a high quantity that they would not be able to sell it at a profitable
price. This combination of economies of scale and market demand creates the barrier to entry,
which led to the Boeing-Airbus oligopoly for large passenger aircraft.
Conditions That Enable Oligopolies

The conditions that enable oligopolies to exist include high entry costs in capital expenditures, legal
privilege (license to use wireless spectrum or land for railroads), and a platform that gains value with more
customers (such as social media). The global tech and trade transformation has changed some of these
conditions: offshore production and the rise of "mini-mills" have affected the steel industry, for example. In
the office software application space, Microsoft was targeted by Google Docs, which Google funded using
cash from its web search business.

Why Are Oligopolies Stable?

An interesting question is why such a group is stable. The firms need to see the benefits of collaboration
over the costs of economic competition, then agree to not compete and instead agree on the benefits of co-
operation. The firms have sometimes found creative ways to avoid the appearance of price-fixing, such as
using phases of the moon. Price-fixing is the act of setting prices, rather than letting them be determined by
the free-market forces. Another approach is for firms to follow a recognized price leader; when the leader
raises prices, the others will follow
How do oligopolies work?
 It is important to note that in real-life oligopolies, the games
(instances of collusion) are sequential; meaning that one firm’s
behavior in one game may influence the game’s outcome in
future periods. In this scenario, we see that the optimal
outcome that generates the most cumulative profits occurs if
both firms collude. This situation would be the best long-run
equilibrium situation that would provide the most benefit to all
the firms.
 Nonetheless, in this equilibrium, firms have an incentive to
cheat and not collude. For example, if both firms agree to set
a price of $10, but Firm A cheats and sets prices at $5, Firm A
will essentially capture the entire market (assuming little to no
differentiation). While this may result in high profits for Firm A
in this game, Firm B now knows that Firm A is a cheater and
thus will never collude again.
 Therefore, the new equilibrium would be the one where
neither firms collude and achieve profits that would occur
under perfect competition (which is significantly less profitable
than colluding). Thus, to realize the best long-run profits, firms
in an oligopoly choose to collude.
Firms behaviour under Oligopoly

Based on the objectives of the firms, the magnitude of

barriers to entry and the nature of government
regulation, there are different possible outcomes in
relation to a firm’s behavior under Oligopoly. These are:

1. Stable prices
2. Price wars
3. Collusion for higher prices
The Prisoner's Dilemma

• The principle problem that these firms face is that each firm has an incentive
to cheat; if all firms in the oligopoly agree to jointly restrict supply and keep
prices high, then each firm stands to capture substantial business from the
others by breaking the agreement undercutting the others. Such competition can
be waged through prices, or through simply the individual company expanding
its own output brought to market.

• Game theorists have developed models for these scenarios, which form a sort
of prisoner's dilemma. When costs and benefits are balanced so that no firm
wants to break from the group, it is considered the Nash equilibrium state for
oligopolies. This can be achieved by contractual or market conditions, legal
restrictions, or strategic relationships between members of the oligopoly that
enable the punishment of cheaters.
Breaking Down Oligopolistic Markets and Firms

• When thinking about oligopolistic companies, it’s important to note that these are the firms
that rule in an oligopolistic market. The businesses are generally the trend and price setters,
seeking out and forming partnerships and deals that establish prices that are higher than the
ruling companies’ marginal costs. This means that oligopoly firms set prices to maximize their
own profit. Ultimately, it leads to partnerships and collaborations that foster success for
themselves and other firms, specifically smaller companies operating within the same market or
industry.

• If one firm in a market lowers its prices on goods and services, attaining optimal sales growth,
firms in direct competition usually follow suit, often creating a price war. Oligopoly companies
generally do not enter such price wars and, instead, tend to funnel more money into research to
improve their goods and services, and into advertising that highlights the superiority of what
they offer over other companies with similar products.
Entering Oligopolistic Markets

• Because of the structure of oligopolies, new firms typically find it difficult – if not impossible –
to tunnel into oligopolistic markets that already exist. This is primarily due to two significant
factors: several well-established and successful large firms already dominate the space, and
those companies typically offer the most premium and well-known goods and services.

• For new companies with similar offerings, breaking into an oligopoly is a struggle. The only
firms that typically manage to do so are those with significant funding; an oligopolistic market
requires large amounts of capital to operate in because the economies of scale generally
ensure that the status quo rarely changes.

• Oligopolies form when several dominant companies rule over a particular market or industry,
making collaboration and partnerships possible between the firms that exist within them. While
an oligopolistic setup can be incredibly beneficial for companies already existing in the
marketplace, they are equally as hard to break into for new companies without substantial
funds.
References:
https://www.economicsonline.co.uk/Business_economics/Oligopoly.html#:~:text=An%20oligopoly%2
0is%20a%20market,said%20to%20be%20highly%20concentrated.
https://www.investopedia.com/terms/o/oligopoly.asp#:~:text=Oligopoly%20is%20a%20market%20st
ructure,is%20two%20or%20more%20firms.
https://corporatefinanceinstitute.com/resources/knowledge/economics/oligopoly/
https://inflateyourmind.com/microeconomics/unit-8-microeconomics/section-3-characteristics-of-an-
oligopoly-industry/
https://opemtextbc.ca/principleofeconomics/chapter/10-2-oligopoly/