characteristics of oligopoly essay

Essay on Oligopoly: Top 8 Essays on Oligopoly | Markets | Microeconomics

Here is a compilation of essays on ‘Oligopoly’ for class 9, 10, 11 and 12. Find paragraphs, long and short essays on ‘Oligopoly’ especially written for school and college students.

Essay on Oligopoly

Essay Contents:

• Essay on Payoff (Profit) Matrix

Essay # 1. Introduction to Oligopoly:

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Two extreme market forms are monopoly (characterised by the existence of a single seller) and perfect competition (characterised by a large number of sellers). Competition is of two types- perfect competition and monopolistic competition. In perfect competition, all sellers sell ho­mogeneous products while in monopolistic competition they sell heterogeneous products. In monopoly there is no rival.

So the monopolist is not concerned with the effect of his actions on rivals. In both types of competition, the number of firms is so large that the actions of any one seller have little, if any, effect on its competitors. An industry with only a few sellers is known as an oligopoly, a firm in such an industry is known as an oligopolist.

Although car-wash is a million rupee business, it is not exactly a product familiar to most consumers. However, often many familiar goods and services are supplied only by a few com­peting sellers, which means the industries we are talking about are oligopolies. An oligopoly is not necessarily made up of large firms. When a village has only two medi­cine shops, service there is just as much an oligopoly as air shuttle service between Mumbai and Pune.

Essentially, oligopoly is the result of the same factors that sometimes produce monopoly, but in somewhat weaker form. Honestly, the most important source of oligopoly is the exist­ence of economies of scale, which give better producers a cost advantage over smaller ones. When these economies of scale are very strong, they lead to monopoly, but when they are not that strong they lead to competition among a small number of firms.

Since an oligopoly con­tains a small number of firms, any change in the firms’ price or output influences the sales and profits of competitors. Each firm must, therefore, recognise that changes in its own policies are likely to elicit changes in the policies of its competitors as well.

As a result of this interdependence, oligopolists face a situation in which the optimal deci­sion of one firm depends on what other firms decide to do. And so there is opportunity for both conflict and cooperation. Oligopoly refers to a market situation in which the number of sellers is few, but greater than one. A special case of oligopoly is monopoly in which there are only two sellers.

Essay # 2. Characteristics of Oligopoly:

The notable characteristics of oligopoly are:

1. Price-Searching Behaviour :

An oligopolist is neither a price-taker (like a competitor) nor a price-maker (like a monopolist). It is a price-searcher. An oligopolist is neither a big enough part of the market to be able to act as a monopolist, nor a small enough part of the market to be able to act as a competitor. But each firm is a dominant part of the market.

In such a situation, competition among buyers will force all the sellers to charge a uniform price for a product. But each firm is sufficiently so large a part of the market that its actions will have noticeable effects upon his rivals. This means that if a single firm changes its output, the prices charged by all the firms will be raised or lowered.

2. Product Characteristics :

In oligopoly, there may be product differentiation as in monopolistic competition (called differ­entiated oligopoly) or a homogeneous product may be traded by all the few dominant firms (as in pure oligopoly).

3. Interdependence and Uncertainty :

In oligopoly no firm can take decision on price independently. It is because the decision to fix a new price or change an existing price will create reactions among the rival firms. But rivals’ reactions cannot be predicted accurately. If a firm reduces its price its rivals may reduce their prices or they may not. So there is lack of symmetry in the behaviour of rival firms.

This type of reaction of rivals is not found in perfect competition or monopolistic competition where all firms change their price in the same direction and by the same magnitude in order to remain competitive and survive in the long run. So the outcome of a firm’s decision is uncertain.

For this reason it is difficult to predict the total demand for the product of an oligopolistic industry. It is still more difficult, and in some situations virtually impossible, to estimate the share of an individual firm in industry’s output.

It is true that the consequences of attempted price variations on the part of an individual seller are uncertain. His rivals may follow his change, or they may not, but they will, in all likelihood, notice it. The results of any action on the part of an oligopolist or even a duopolist depend upon the reactions of his rivals. In short, it is not possible to define general price- quantity relations for an individual firm, since reaction patterns of rivals are highly uncertain and almost completely unknown.

4. Different Reaction Patterns and Use of Models :

It is not true to say that, in oligopoly, profit is always maximised. It is because an oligopolist does not have control over all the variables which affect his profit. Moreover, a variety of possible reaction patterns is possible in this market—there is a conjectural variation in this market.

Just as firm A’s profit depends on the output of firm B also, firm B’s profit, in its turn, depends on firm A’s output. This is why various models are used to describe the diverse behaviour of oligopoly markets where a variety of outcomes is possible.

5. Non-Price Competition :

As in monopolistic competition there is not only price competition but non-price competition as well in oligopoly (and, to some extent, in duopoly). For example, advertising is often a life and death question in this type of market due to strategic behaviour of all firms. In most oligopoly situations we find intermediate outcomes. Economists are yet to emerge with a definite behaviour pattern in oligopoly.

Essay # 3. Scope of Study of Oligopoly :

Here we study a few of the many possible reaction patterns in duopoly and oligopoly situa­tions. The focus is on pure oligopoly. Here we assume that all firms produce a homogeneous product. We do not discuss the case of differentiated oligopoly and the issue of selling cost (advertising) separately. Of course, we discuss briefly Baumol’s sales maximisation hypoth­esis—without and with advertising.

The focus here is on the interdependence of the various sellers’ reactions, which is the essential distinguishing feature of oligopoly. If the influence of one seller’s quantity decision from the profit of another, δπ i /δq j , is negligible, the industry must be either perfectly competi­tive or monopolistically competitive. If δπ i /δq j , is perceptible, the industry is duopolistic or oligopolistic.

The optimum quantity and maximum profit of a duopolist or oligopolist depend upon the actions of the firms belonging to the industry. He can control only his own output level (or price, if his product is differentiated), but he has no direct control over other variables which are likely to (or do) affect his profits. In truth, the profit of each oligopolist is the result of the interaction of the decisions of all players in the market.

Since there are no generally accepted behavioural assumptions for oligopolists and duopolists as is found in other market forms, there are diverse patterns of behaviour and many different solutions for oligopolistic and duopolistic markets. Each solution is based on different types of models and each model is based on a different behavioural assumption or a set of assumptions.

Here we start with one or two simple duopoly models. The same analysis (solution) can be extended to cover any oligopolistic market. The earliest model of duopoly behaviour is the Cournot model, with which we may start our review of different oligopoly models. We end with the game theoretic treatment of oligopoly which shows decision-making under conflict.

Essay # 4. Models of Oligopoly:

1. the cournot model :.

The Cournot model (presented in 1838) is based on the analysis of a market in which two firms produce a homogeneous product. Augustin Cournot (a French economist) noticed that only two firms were producing mineral water for sale. He argued that each firm would choose quan­tity that would maximise profit, taking the quantity marketed by its competitor as given.

Two main features of the model are:

(i) Each firm chooses a quantity of output instead of price; and

(ii) In choosing its output each firm takes its rival’s output as given.

In Cournot’s model, then, strategies are quantities of output. Here we assume that firms produce a homoge­neous good and know the market demand curve.

Each firm must decide how much to produce, and the two firms make their decisions at the same time. When taking its production decision, each duopolist takes into consideration its competitor. It knows that its competitor is also de­ciding how much to produce, and the market price will depend on the total output of both firms.

The essence of the Cournot model is that each firm treats the output level of its competitor as fixed and then decides how much to produce. Each Cournot’s duopolist believes that the other’s quantity will not change. In Fig. 1 when I produces Q M , II maximises its profit by producing 1/4Q C . In order to sell Q M plus Q c , the price must fall to P 1 . Here Q M is the mo­nopoly output which is half the competitive output Q c .

The inverse demand function, stating price as a function of the aggregate quantity sold, is expressed as:

P =f (q 1 ) + q 2 … (1)

where q 1 and q 2 are the output levels of the duopolists. The total revenue of each duopolist depends upon his own output level as also as that of his rival:

R 1 = q 1 f 1 (q 1 + q 2 ) = R 1 (q 1 , q 2 )

R 2 = q 2 f 2 (q 1 + q 2 ) = R 2 (q 1 , q 2 ) … (2)

The profit of each equals his total (sales) revenue, less his cost, which depends upon his output level above:

π 1 = R 1 (q 1 , q 2 ) – C 1 (q 1 )

π 2 = R 2 (q 1 , q 2 ) – C 2 (q 2 ) … (3)

The basic behavioural assumption of the Cournot model is that each duopolist maximises his profit on the assumption that the quantity produced by his rival is invariant with respect to his own decision regarding output quantity. Duopolist I maximises π 1 with reference to q 1 , treating q 2 as a parameter, and duopolist II maximises π 2 , with reference to q 2 , treating q 1 as a parameter. Setting the partial derivatives of (3) equal to zero, we get:

The solution of (7) is

Here OM is the marginal cost of producing the commodity. The second firm’s price is p 2 . The first firm’s profit function is composed of three segments. When p 1 < p 2 , the first firm captures the entire mar­ket, and its profit increases as its price increases. When p 1 > p 2 , the two firms split the total profits equal to distance CA, and each makes a profit equal to CB. When p 1 >p 2 , the first firm’s profit is zero because it sells nothing when its price exceeds the second firm’s price.

Criticisms:

The Bertrand model has been criticised on two main grounds. First, when firms produce a homogeneous good, it is more natural to compete by setting quantities rather than prices. Second, even if firms do set prices and choose the same price (as the model predicts), what share of total sales will go to each one? The model assumes that sales would be divided equally among the firms, but there is no reason why this must be the case.

However, despite these shortcomings, the Bertrand model is useful because it shows how the equilibrium out­come in an oligopoly can depend crucially on the firms’ choice of strategic variable.

3. The Stackelberg Model :

The Stackelberg model (presented by the German economist Heinrich von Stackelberg) is a modified version of the Cournot model. In the Cournot model, we assume that two duopolists make their output decisions at the same time. The Stackelberg model examines what happens if one of the firms can set its output first. The Stackelberg model of duopoly is different from the Cournot model, in which neither firm has any opportunity to react.

The model is based on the assumption that the profit of each duopolist is a function of the output levels of both:

π 1 = g 1 (q 1 , q 2 ) π 2 = g 2 (q 1 , q 2 ) … (1)

The Cournot solution is found out by maximising π 1 with reference to q 1 , assuming q 2 to be constant and π 2 with reference to q 2 , assuming q 1 to be constant. In general, each firm might make some other assumption about the response (reaction) of its only rival. In such a situation, profit-maximisation by the two duopolists requires the fulfillment of the following two condi­tions:

Since the firm’s demand curve is kinked, its combined marginal revenue curve is discon­tinuous. This means that the firm’s cost can change without leading to price change. In this figure, marginal cost could increase but would still equal marginal revenue at the original out­put level. This means that price remains the same.

The kinked demand curve model fails to explain oligopoly pricing. It says nothing about how marginal revenue firms arrived at the original price P̅ to start with. In fact, some arbitrary price is taken as both the starting and end point of our journey. Why firms did not arrive at some other price remains an open question. It just describes price rigidity but cannot explain it. In addition, the model has not been supported by empirical tests. In reality, rival firms do match price increases as well as price cuts.

Market-sharing Price Leadership :

Oligopolists often collude—jointly restrict supply to raise price and cooperate. This strategy can lead to higher profits. Collusion is, however, illegal. Moreover, one of the main impedi­ments to implicitly collusive pricing is the fact that it is difficult for firms to agree (without talking to each other) on what the price should be.

Coordination becomes particularly problem­atic when cost and demand conditions—and, thus, the ‘correct’ price—are changing. However, benefits of cooperation can be enjoyed without actually colluding. One way of doing this is through price leadership. Price leadership may be provided by a low-cost firm or a dominant firm.

In this context, we may draw a distinction between price signalling and price leadership. Price signalling is a form of implicit collusion that sometimes gets around this problem. For example, a firm might announce that it has raised its price with the expectation that its competi­tors will take this announcement as a signal that they should also raise prices. If competitors follow, all of the firms (at least, in the short run) will earn higher profits.

At times, a pattern is established whereby one firm regularly announces price changes and other firms in the industry follow. This type of strategic behaviour is called price leadership— one firm is implicitly recognised as the ‘leader’. The other firms, the ‘price followers’, match its prices. This behaviour solves the problem of coordinating price: Everyone simply charges what the leader is charging.

Price leadership helps to overcome oligopolistic firms’ reluctance to change prices—for fear of being undercut. With changes in cost and demand conditions, firms may find it increas­ingly necessary to change prices that have remained rigid for some time. In that case, they wait for the leader to signal when and by how much price should change.

Sometimes a large firm will naturally act as a leader; sometimes different firms will act as a leader from time to time. In this context, we may discuss the dominant Firm model of leadership. This is known as market- sharing price leadership.

6. The Dominant Firm Model :

In some oligopolistic markets, one large firm has a major share of total sales while a group of smaller firms meet the residual demand by supplying the remainder of the market. The large firm might then act as a dominant firm, setting a price that maximises its own profits.

The other firms, which individually could exert little, if any, influence over price, would then act as perfect competitors; they all take the price set by the dominant firm as given and produce accordingly. But what price should the dominant firm set? To maximise profit, it must take into account how the output of the other firms depends on the price it sets.

Fig. 5 shows how a dominant firm sets its prices. A dominant firm is one with a large share of total sales that sets price to maximise profits, taking into account the supply response of smaller firms. Here D is the market demand curve and S F is the supply curve (i.e., the aggregate marginal cost curves of the smaller firms, called competitive fringe firms). The dominant firm must determine its demand curve D D .

This curve is just the difference between market demand and the supply of fringe firms. For example, at price P 1 , the supply of fringe firms is just equal to market demand. This means that the dominant firm can sell nothing at this price. At a price P 2 or less, fringe firms will not supply any of the good, in which case, the dominant firm faces the market demand curve. If price lies between P 1 and P 2 , the dominant firm faces the demand curve D D .

The marginal cost curve of the dominant firm corresponding to D D is MR D . The dominant firm’s marginal cost curve is MC D . In order to maximise its profit, the dominant firm produces quantity Q D at the interaction of MR D and MC D . From the demand curve D D , we find P 0 . At this price, fringe firms sell a quantity Q F , thus the total quantity sold is Q T = Q D + Q F .

7. Collusive Oligopoly: The Cartel Model :

Various models have been formulated to explain the strategic behaviour of firms in an oligopolistic market. A price (cut-throat) competition exists among the rivals who try to oust the others from the market. Sometimes there ex­ists a dominant firm that acts as the leader in the market while the others just follow the leader.

As a result, there happens to be a clear possibil­ity of the formation of a cartel by the rival firms in an oligopolistic market in order to eliminate competition among themselves. This is termed as “collusive oligopoly” because the firms some­how manage to combine together in order to be­have collectively as a single monopoly.

Now let us see graphically what incentives the firms get for forming a cartel. In Fig. 6, the market demand curve is given by the D M the total supply curve is the horizontal summation of the marginal cost curves of all existing firms in the industry, which is denoted by MC M .

The market equilibrium is attained at the point of intersection between the D M (demand curve) and the marginal cost curve MC M , if the firms compete with each other. OP M is the equilibrium price at which the total output of the industry is OQ M .

In order to determine its own quantity, each firm equates this price to its marginal cost. The sum of the quantities of the firms is OQ. If the firms form a cartel in order to act as a monopolist, the price rises to OP ‘ M and the quantity is reduced to OQ ‘ M to be in equilibrium. Now, when the quantity is being reduced by Q M Q’ M , then all the firms together save the cost represented by the area below the MC M curve which is Q M E M F M Q ‘ M .

Thus, a rise in price due to a reduction in the quantity is followed by a decrease in the total revenue represented by the area below the MR M curve, i.e., area Q M G M F M Q’ M . This, in turn, shows that the cost saved exceeds the loss in revenue and, so, all the firms taken as a whole can increase their profit represented by the area E M F M G M . The prospect of earning this extra profit actually acts as the incentive to form a cartel in the oligopoly market structure.

Since the cartel is formed, all firms agree together to produce the total quantity OQ’ M . In order to carry this out, each and every firm is allotted a quota or a certain portion of production such that the sum of all quotas is equal to OQ M . For this, the best way of quota allotment would be to treat each firm as a separate entity (plant) under the same monopolist. Thus, all the firms have the same marginal cost (MC) such that MC = MR (marginal revenue).

Finally, the total profit is maximised because the total output is produced at the minimum cost.

Each and every firm can increase its profit by reducing the profits of other firms, simply by increasing its output quantity above the allotted quota. The system of cartel formation must guard against the desire of individual firms to violate the quota and the cartel breaks down when the cost of guarding against quota violation is very high.

The OPEC is an example of collusive oligopoly or cartel in which members (producers) explicitly agree to cooperate in setting prices and output levels. All the producers in an industry need not and often do not join the cartel. But if most producers adhere to the cartel’s agree­ments, and if market demand is sufficiently inelastic, the cartel may drive prices well above competitive levels.

Two conditions for success:

Two conditions must be fulfilled for cartel success. First, a stable cartel organisation must be formed whose members agree on price and production levels and both adhere to that agreement. The second condition is the potential for monopoly power. A cartel cannot raise price much if it faces a highly elastic demand curve. If the potential gains from cooperation are large, cartel members will have more incentive to share their organisa­tional problems.

Analysis of Cartel Pricing:

Cartel pricing can be analysed by using the dominant firm model of oligopoly. It is because a cartel usually accounts for only a portion of total production and must take into account the supply response of competitive (non-cartel) producers when it sets price. Here we illustrate the OPEC oil cartel.

Fig. 7 illustrates the case of OPEC. Total demand TD is the world demand curve for crude oil, and S c is the competitive (non-OPEC) supply curve. The demand for OPEC oil D 0 is the difference between total demand (TD) and competitive supply (SC), and MR 0 is the corresponding marginal revenue curve.

MC 0 is OPEC’s marginal cost curve; OPEC has much lower production costs than do non-OPEC producers. OPEC’s marginal revenue and marginal cost are equal at quantity Q 0 , which is the quantity that OPEC will produce. Here we see from OPEC s demand curve that the price will be P 0 .

Since both total demand and non-OPEC supply are inelastic, the demand for OPEC oil is also fairly inelastic; thus the cartel has substantial monopoly. In the 1970s, it used that power to drive prices well above competitive levels.

In this context, it is important to distinguish between short-run and long-run supply and demand curves. The total demand and non-OPEC supply curves in Fig. 7 apply to short-or intermediate-run analysis. In the long run, both demand and supply will be much more elastic, which means that OPEC’s demand curve will also be much more elastic.

We would thus expect that, in the long run, OPEC would be unable to maintain a price that is so much above the competitors’ level. In truth, during 1982-99, oil prices fell steadily, mainly because of the long- run adjustment of demand and non-OPEC supply.

However, cartel is not an unmixed blessing. No doubt cartel members can talk to one an­other in order to formalize an agreement. But it is not that easy to reach a consensus. Different members may have different costs, different assessments of market demand, and even different objectives, and they may, therefore, want to set prices at different levels.

Furthermore, each member of the cartel will be tempted to “cheat” by lowering its price slightly to capture a larger market share than it was allotted. Most often, only the threat of a long-term return to competi­tive prices deters cheating of this sort. But if the profits from cartelization are large enough, that threat may be sufficient.

Essay # 5. Sales (Revenue) Maximisation :

W.J. Baumol presented an alternative hypothesis to profit maximisation, viz., sales (revenue) maximisation. He has suggested that large oligopolistic firms do not maximise profit, but rather maximise sales revenue, subject to the constraint that profit equals or exceeds some minimum accepted level. Various empirical studies support Baumol’s hypothesis. And it accurately cap­tures some aspects of oligopolistic firms’ behaviour.

Most important, when firms are uncertain about their demand curve they actually face, or, when they cannot accurately estimate the marginal costs of their output (due to uncertainty about factor prices, or when they produce more than one product), the decision to try to maximise sales appears to be consistent with their long-term survival. This is why many oligopolist firms seek to maximise their market share in order to protect themselves from the adverse effects of uncertain market environment.

Graphical Analysis :

A revenue-maximising oligopolist would choose to produce that level of output for which MR = 0. When MR = 0, TR is maximum. That is, the oligopolist should proceed to the point at which selling any extra unit(s) actually leads to a fall in TR. This choice is illustrated in Fig. 8.

For the firm which faces the demand curve D, TR is maximum when output is q s . For q < q s , MR is positive. This means that selling more units increases TR (though not necessarily profit). For q > q s , however, MR is negative. So further sales actually reduce TR because of price cuts that are necessary to induce consumers to buy more. We know that

MR = P(1 – 1/e p ) … (1)

MR = 0 if e p = 1, in which case TR will be maximum. TR is constant in a small neighbourhood of that output quantity at M 1 P = 0, TR is maximum, and when TR is maximum, e p = 1.

We may now compare the revenue-maximisation choice with the profit-maximising level of output, q s . At q p , MR equals marginal cost MC in Fig. 8. Increasing output beyond q p would reduce profits since MR < MC. Even though TR continues to increase up to q s , units of output beyond q p bring in less than they cost to produce. Since marginal revenue is positive at q p , equation (1) shows that demand must be elastic (e p > 1) at this point.

Essay # 6. Constrained Revenue Maximisation :

A firm that chooses to maximise TR is neither taking into account its costs nor the profitabil­ity of the output that it is selling. And it is quite possible that the output level q s in Fig. 8 yields negative profit to the firm. However, it is not possible to any firm to survive for ever with negative profits. So it may be more realistic to assume that firms do meet some mini­mum level (target rate) of profit from their activities.

Thus, even though oligopolists may be prompted to produce more than q p with a view to maximising revenue, they may produce less than q p units in order to ensure an acceptable level of profit. They will, therefore, behave as constrained revenue maximises and will choose to produce an output level which lies between q p and q s .

Mathematical Analysis :

Pure Oligopoly: In a pure oligopoly, there are only two or three firms in the market that are not influenced by any other firm. This oligopoly environment is rife with fierce competition, as each business relentlessly fights to dominate the market.

Imperfect Oligopoly: In an imperfect oligopoly, there is more than one dominant firm but the market is still dominated by a few key players. In this type of oligopolistic market, companies work together to maximize their profits by fixing prices and engaging in less fierce competition.

Open Oligopoly: In an open oligopoly, there are many small firms in the market that can compete with each other but are not able to gain control over the entire market. This oligopoly is marked by price battles and strategic campaigns, as each company attempts to capitalize on the adversaries’ vulnerable spots.

Closed Oligopoly: In a closed oligopoly, there are few firms in the market and they have gained dominance over the entire industry. In this form of oligopoly, firms have secured a certain degree of market dominance, leading to an absence of competition.

Collusive Oligopoly: In a collusive oligopoly, firms form agreements to set prices and production levels in order to maximize their collective profits. Oligopolies of this nature are typified by both price stability and lucrative profits for all businesses involved.

Competitive Oligopoly: In a competitive oligopoly, there are few large firms but they compete aggressively with each other through pricing strategies, promotions, and advertising campaigns. This oligopoly structure is typified by fierce rivalry and prices that are considerably lower than those encountered in traditional or distorted oligopolies.

Partial Oligopoly: In a partial oligopoly, there are a few large firms that dominate the market but there are also many small firms that compete with each other. This oligopoly is defined by the intense rivalry among small firms and an incapability to control the entire market by any one firm.

Total Oligopoly: In a total oligopoly, only one firm has control over the entire industry and its pricing strategies govern the market. This type of oligopoly is known for its stable prices and exceptional returns to the primary business.

Organized Oligopoly: In an organized oligopoly, several large firms cooperate with each other in order to gain control over the entire market. This type of oligopoly is characterized by stable prices and increased profits for all participating firms.

Syndicated Oligopoly: In a syndicated oligopoly, several firms join together in order to gain control over the entire market. This type of oligopoly results in steady pricing increased profits for the firms involved, and a decrease in market competition.

Examples of Oligopoly

Motor Vehicles in the US: In the United States, motor vehicles are a prime example of an oligopoly. The US market is primarily dominated by three firms: General Motors , Ford , and Chrysler , which together account for approximately 70% of the total sales.

News Media: The news media industry is another example of an oligopoly, as there are only a few large media companies that control the entire market. These companies, such as NBC Universal, Disney , and Time Warner, are known for their immense power when it comes to influencing public opinion.

Breakfast Cereals: The breakfast cereals industry is an oligopoly in which only a handful of firms have significant control over the entire market. Companies like Kellogg’s, Quaker Oats, and General Mills dominate the global market for breakfast cereals.

Mobile Phones: The mobile phone industry is dominated by a few large players such as Apple , HTC , and Samsung . These companies have secured an overwhelming portion of the total market share, leaving only marginal room for new entrants or small businesses.

Beer: The beer industry is a prime example of an oligopoly, as it is dominated by only a few large firms. Companies like Anheuser-Busch InBev, MillerCoors, and Heineken control more than 70% of the total market share in the United States.

Conclusion!

In the end, oligopoly industries have characteristics that make them distinct from other market structures. They work in a competitive market and require businesses to be savvy in order to stay competitive.

Oligopoly industries can be difficult to enter and exit, as the few firms in the market tend to hold significant market power. Market forces of demand and supply still apply, however firms are more likely to focus on strategic pricing decisions in order to maximize profits. The marginal revenue curve is an important concept to understand in oligopolies, as it can provide guidance on how much revenue a firm will gain from a given price.

Understanding the oligopoly characteristics will give businesses an edge in making strategic decisions and staying competitive in their markets. In a world of intense competition, businesses in these industries must be prepared to adapt quickly in order to remain successful.

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Definition of oligopoly

An oligopoly is an industry dominated by a few large firms. For example, an industry with a five-firm concentration ratio of greater than 50% is considered an oligopoly.

Examples of oligopolies

Car industry – economies of scale have caused mergers so big multinationals dominate the market. The biggest car firms include Toyota, Hyundai, Ford, General Motors, VW.

• Petrol retail – see below.
• Pharmaceutical industry
• Coffee shop retail – Starbucks, Costa Coffee, Cafe Nero
• Newspapers – In the UK market share is dominated by tabloids Daily Mail, The Sun, The Mirror, The Star, Daily Express.
• Book retail – In the UK market share is dominated by Waterstones, Amazon and smaller firms like Blackwells.

The main features of oligopoly

• An industry which is dominated by a few firms.

The UK definition of an oligopoly is a five-firm concentration ratio of more than 50% (this means the five biggest firms have more than 50% of the total market share) The above industry (UK petrol) is an example of an oligopoly. See also: Concentration ratios

• Interdependence of firms – companies will be affected by how other firms set price and output.
• Barriers to entry. In an oligopoly, there must be some barriers to entry to enable firms to gain a significant market share. These barriers to entry may include brand loyalty or economies of scale. However, barriers to entry are less than monopoly.
• Differentiated products. In an oligopoly, firms often compete on non-price competition . This makes advertising and the quality of the product are often important.
• Oligopoly is the most common market structure

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:

• Stable prices (e.g. through kinked demand curve) – firms concentrate on non-price competition.
• Price wars (competitive oligopoly)
• Collusion- leading to higher prices.

The kinked demand curve model

This model suggests that prices will be fairly stable and there is little incentive for firms to change prices. Therefore, firms compete using non-price competition methods.

• This assumes that firms seek to maximise profits.
• If they increase the price, then they will lose a large share of the market because they become uncompetitive compared to other firms. Therefore demand is elastic for price increases.
• If firms cut price then they would gain a big increase in market share. However, it is unlikely that firms will allow this. Therefore other firms follow suit and cut-price as well. Therefore demand will only increase by a small amount. Therefore demand is inelastic for a price cut.
• Therefore this suggests that prices will be rigid in oligopoly

The diagram above suggests that a change in marginal cost still leads to the same price, because of the kinked demand curve.  Profit maximisation occurs where MR = MC at Q1.

Evaluation of kinked demand curve

• In the real world, prices do change.
• Firms may not seek to maximise profits,  but prefer to increase market share and so be willing to cut prices, even with inelastic demand.
• Some firms may have very strong brand loyalty and be able to increase the price without demand being very price elastic.
• The model doesn’t suggest how prices were arrived at in the first place.

Firms in an oligopoly may still be very competitive on price, especially if they are seeking to increase market share. In some circumstances, we can see oligopolies where firms are seeking to cut prices and increase competitiveness.

A feature of many oligopolies is selective price wars. For example, supermarkets often compete on the price of some goods (bread/special offers) but set high prices for other goods, such as luxury cake.

• Another possibility for firms in oligopoly is for them to collude on price and set profit maximising levels of output. This maximises profit for the industry.

In the above example, the industry was initially competitive (Qc and Pc). However, if firms collude, they can agree to restrict industry supply to Q2, and increase the price to P2. This enables the industry to become more profitable. At Qc, firms made normal profit. But, if they can stick to their quotas and keep the price at P2, they make supernormal profit.

• Collusion is illegal, but tacit collusion may be hard to spot.
• For collusion to be effective, there need to be barriers to entry.
• A cartel is a formal collusive agreement. For example, OPEC is a cartel seeking to control the price of oil.

See: Collusion

Collusion and game theory

Game theory is looking at the decisions of firms based on the uncertainty of how other firms will react. It illustrates the concept of interdependence. For example, if a firm agrees to collude and set low output – it relies on the other firm sticking to the collusive agreement. If the firm restricts output (sets the High price), and then the other firm betrays its agreement (setting low price). The firm will be worse off.

• This shows different options. If the market is non-collusive, firms make £4m each.
• If they collude, they make £8m.
• But, if they are colluding there is an incentive for one of the firms to exceed quota and increase output. If a firm sets low price whilst the other sets a high price, their profit rises to £10m

Collusion and game theory is more complex if we add in the possibility of firms being fined by a government regulator.

Collusion is illegal and firms can be fined. Usually, the first firm that confesses to the regulator is protected from prosecution, so there is always an incentive to be the first to confess.

• Pricing strategies
• Diagrams for oligopoly
• Game Theory

Defining and measuring oligopoly

Concentration ratios

Example of a hypothetical concentration ratio, fixed broadband services, fuel retailing, further examples, the herfindahl – hirschman index (h-h index), key characteristics, interdependence.

• Whether to compete with rivals, or collude with them.
• Whether to raise or lower price, or keep price constant.
• Whether to be the first firm to implement a new strategy, or whether to wait and see what rivals do. The advantages of ‘going first’ or ‘going second’ are respectively called 1st and 2nd-mover advantage. Sometimes it pays to go first because a firm can generate head-start profits. 2nd mover advantage occurs when it pays to wait and see what new strategies are launched by rivals, and then try to improve on them or find ways to undermine them.

Barriers to entry

Natural entry barriers include:, economies of large scale production., ownership or control of a key scarce resource, high set-up costs, high r&d costs, artificial barriers include:, predatory pricing, limit pricing, superior knowledge, predatory acquisition, advertising, a strong brand, loyalty schemes, exclusive contracts, patents and licences, vertical integration, collusive oligopolies, types of collusion, competitive oligopolies, pricing strategies of oligopolies.

• Oligopolists may use predatory pricing to force rivals out of the market. This means keeping price artificially low, and often below the full cost of production.
• They may also operate a limit-pricing strategy to deter entrants, which is also called entry forestalling price .
• Oligopolists may collude with rivals and raise price together, but this may attract new entrants.
• Cost-plus pricing is a straightforward pricing method, where a firm sets a price by calculating average production costs and then adding a fixed mark-up to achieve a desired profit level. Cost-plus pricing is also called rule of thumb pricing.There are different versions of cost-pus pricing, including  full cost pricing , where all costs - that is, fixed and variable costs - are calculated, plus a mark up for profits, and contribution pricing , where only variable costs are calculated with precision and the mark-up is a contribution to both fixed costs and profits.

Non-price strategies

• Trying to improve quality and after sales servicing, such as offering extended guarantees.
• Spending on advertising, sponsorship and product placement - also called hidden advertising – is very significant to many oligopolists. The UK's football Premiership has long been sponsored by firms in oligopolies, including Barclays Bank and Carling.
• Sales promotion, such as buy-one-get-one-free (BOGOF), is associated with the large supermarkets, which is a highly oligopolistic market, dominated by three or four large chains.
• Loyalty schemes, which are common in the supermarket sector, such as Sainsbury’s Nectar Card and Tesco’s Club Card .
• How successful is it likely to be?
• Will rivals be able to copy the strategy?
• Will the firms get a 1st - mover advantage?
• How expensive is it to introduce the strategy? If the cost of implementation is greater than the pay-off, clearly it will be rejected.
• How long will it take to work? A strategy that takes five years to generate a pay-off may be rejected in favour of a strategy with a quicker pay-off.

Price stickiness

Kinked demand curve.

Maximising profits

A game theory approach to price stickiness.

• Raise price
• Lower price
• Keep price constant

The Prisoner’s Dilemma

• Higher prices or hidden prices, such as the hidden charges in credit card transactions
• Lower output
• Restricted choice or other limiting conditions associated with the transaction

Examples of Oligopoly

Evaluation of oligopolies, the disadvantages of oligopolies.

• High concentration reduces consumer choice.
• Cartel-like behaviour reduces competition and can lead to higher prices and reduced output.
• Given the lack of competition, oligopolists may be free to engage in the manipulation of consumer decision making. By making decisions more complex - such as financial decisions about mortgages - individual consumers fall back on heuristics and rule of thumb processes, which can lead to decision making bias and irrational behaviour, including making purchases which add no utility or even harm the individual consumer.
• Firms can be prevented from entering a market because of deliberate barriers to entry .
• There is a potential loss of economic welfare.
• Oligopolists may be allocatively and productively inefficient .

The advantages of oligopolies

• Oligopolies may adopt a highly competitive strategy, in which case they can generate similar benefits to more competitive market structures , such as lower prices. Even though there are a few firms, making the market uncompetitive, their behaviour may be highly competitive.
• Oligopolists may be dynamically efficient in terms of innovation and new product and process development. The super-normal profits they generate may be used to innovate, in which case the consumer may gain.
• Price stability may bring advantages to consumers and the macro-economy because it helps consumers plan ahead and stabilises their expenditure, which may help stabilise the trade cycle.

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Game Theory

Monopolistic competition

What Makes a Market an Oligopoly?

Do you know of any industries in which just three or four companies supply most of a specific product?

Some examples:

• From the 1950s to the 1980s, three major broadcast television networks dominated the U.S. airwaves.
• After a series of mergers between 2005 and 2015, four major airlines controlled much of the U.S. market, as a November 2018 Page One Economics essay described.
• Even more recently, shortages and price increases brought attention to the U.S. baby formula market and global insulin market, which also had just a few suppliers.

Those markets could be considered “oligopolies”—markets in which only a few sellers or suppliers dominate.

Suppliers and sellers in an oligopoly can command higher prices than companies in a competitive market, and if one company in an oligopoly stops producing, it has a bigger effect on supply than it would in a competitive market.

Read on for more comparisons of oligopolies to other types of markets and to learn how to tell whether a particular market could be considered an oligopoly.

What Is an Oligopoly?

As the table shows, in addition to having only a few sellers or suppliers dominating the market, an oligopoly has barriers to entering the market, and “there are few close substitutes for the product.”

In other words, certain conditions make it difficult for potential competitors to start selling or supplying a particular product or service within that industry, and there aren’t many alternatives that could be used instead. Monopolies—markets in which one firm dominates—also have those barriers.

“Barriers to entry” could include factors such as costly equipment needed to produce a product, patents restricting who can use an invention, and government regulations that are difficult to meet, as a Corporate Finance Institute article outlined.

What Are Examples of Barriers to Entry?

In the case of the U.S. infant formula market, barriers to entry have included tariffs and Food and Drug Administration standards . (Some of the infant formula market barriers were waived to help ease the shortage last year.)

Until the expansion of the cable TV market in the 1980s, the limited availability of broadcast frequencies helped to restrict the number of television networks, with the Federal Communications Commission in charge of allocating portions of the broadcast spectrum to stations.

Barriers to entry in the airline industry include high startup costs, such as for purchasing airplanes, competition for airport gates and large economies of scale, the Page One Economics essay said.

Government can put up barriers, as a St. Louis Fed Econ Lowdown lesson on market structures (PDF)  outlined in discussing monopolistic markets. Such markets are rare, according to the lesson.

“Most commonly, [monopolistic markets] occur because government has granted a single firm the opportunity to supply a good or service. This is known as a ‘natural monopoly, ’ ” according to the lesson, which gives the examples of electric and natural gas providers. Because of the expensive infrastructure needed for those services, such as wires and pipes entering people’s homes, it’s cheaper for one firm to provide the service than to build infrastructure needed for true competition.

“In exchange, government often regulates prices in these markets to ensure that these firms do not take advantage of their market power,” the lesson says.

How Can You Tell If a Market Is an Oligopoly?

A “concentration ratio” is one tool that can indicate whether a market is an oligopoly.

A concentration ratio is the combined market share of the largest firms in an industry, according to Oxford Reference . That is, it’s the percentage of the industry’s products or services provided by those firms.

The number of firms used for the ratio can vary. A “four-firm” ratio is often used as a benchmark to show market structure, according to Oxford. But the ratios also can be calculated using the market share from the eight, five or three largest firms in the market, according to a September 2020 Investopedia article.

“A rule of thumb is that an oligopoly exists when the top five firms in the market account for more than 60% of total market sales,” the article says. “If the concentration ratio of one company is equal to 100%, this indicates that the industry is a monopoly.”

In 2015, the four major airlines controlled 80% of the U.S. market, the Page One Economics essay said. Three manufacturers have more than 90% of the global insulin market , according to a July 2022 press release from Grand View Research, a global market research and consulting company. That would make those markets oligopolies, according to the Investopedia rule of thumb.

What Are Two Types of Oligopolistic Markets?

Oligopolistic markets differ, and different types of markets have different effects on prices, as the Econ Lowdown lesson illustrates.

One such market is a collusive oligopoly , which has a few sellers who work together “to divide the market, set prices, or limit production,” the lesson says. Companies might, for example, agree to limit production to drive up prices. Such collusion is often illegal.

In a competitive oligopoly , the few sellers compete, which keeps the prices lower than they would be in a collusive oligopoly.

In general, more competition results in lower prices for consumers. So, a perfect competition market structure, in which lots of companies provide the same product, would result in lower prices, while a monopoly could mean the highest prices for consumers. Depending on whether they are collusive or competitive, oligopolies can be more like monopolies or more like perfect competition, respectively, as a Khan Academy video explains.

Can Oligopolies Change?

Market structures aren’t necessarily fixed, as the Page One Economics essay illustrated with the example of U.S. airlines.

Airline ticket prices declined as low-cost carriers started expanding their routes in 2016, the essay said. A chart from online database FRED shows the downward trend in airfares before the COVID-19 pandemic.

“The proliferation of low-cost flights in recent years has pushed the airline industry, which was arguably an oligopoly, toward monopolistic competition,” the essay said.

Heather Hennerich is a senior editor with the St. Louis Fed External Engagement and Corporate Communications Division.

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Chapter 10. Monopolistic Competition and Oligopoly

10.2 Oligopoly

Learning objectives.

• Explain why and how oligopolies exist
• Contrast collusion and competition
• Interpret and analyze the prisoner’s dilemma diagram
• Evaluate the tradeoffs of imperfect competition

Many purchases that individuals make at the retail level are produced in markets that are neither perfectly competitive, monopolies, nor monopolistically competitive. Rather, they are oligopolies. Oligopoly arises when a small number of large firms have all or most of the sales in an industry. Examples of oligopoly abound and include the auto industry, cable television, and commercial air travel. Oligopolistic firms are like cats in a bag. They can either scratch each other to pieces or cuddle up and get comfortable with one another. If oligopolists compete hard, they may end up acting very much like perfect competitors, driving down costs and leading to zero profits for all. If oligopolists collude with each other, they may effectively act like a monopoly and succeed in pushing up prices and earning consistently high levels of profit. Oligopolies are typically characterized by mutual interdependence where various decisions such as output, price, advertising, and so on, depend on the decisions of the other firm(s). Analyzing the choices of oligopolistic firms about pricing and quantity produced involves considering the pros and cons of competition versus collusion at a given point in time.

Why Do Oligopolies Exist?

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.

Similarly, 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.

The product differentiation at the heart of monopolistic competition can also play a role in creating oligopoly. For example, firms may need to reach a certain minimum size before they are able to spend enough on advertising and marketing to create a recognizable brand name. The problem in competing with, say, Coca-Cola or Pepsi is not that producing fizzy drinks is technologically difficult, but rather that creating a brand name and marketing effort to equal Coke or Pepsi is an enormous task.

Collusion or Competition?

When oligopoly firms in a certain market decide what quantity to produce and what price to charge, they face a temptation to act as if they were a monopoly. By acting together, oligopolistic firms can hold down industry output, charge a higher price, and divide up the profit among themselves. When firms act together in this way to reduce output and keep prices high, it is called collusion . A group of firms that have a formal agreement to collude to produce the monopoly output and sell at the monopoly price is called a cartel . See the following Clear It Up feature for a more in-depth analysis of the difference between the two.

Collusion versus cartels: How can I tell which is which?

In the United States, as well as many other countries, it is illegal for firms to collude since collusion is anti-competitive behavior, which is a violation of antitrust law. Both the Antitrust Division of the Justice Department and the Federal Trade Commission have responsibilities for preventing collusion in the United States.

The problem of enforcement is finding hard evidence of collusion. Cartels are formal agreements to collude. Because cartel agreements provide evidence of collusion, they are rare in the United States. Instead, most collusion is tacit, where firms implicitly reach an understanding that competition is bad for profits.

The desire of businesses to avoid competing so that they can instead raise the prices that they charge and earn higher profits has been well understood by economists. Adam Smith wrote in Wealth of Nations in 1776: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

Even when oligopolists recognize that they would benefit as a group by acting like a monopoly, each individual oligopoly faces a private temptation to produce just a slightly higher quantity and earn slightly higher profit—while still counting on the other oligopolists to hold down their production and keep prices high. If at least some oligopolists give in to this temptation and start producing more, then the market price will fall. Indeed, a small handful of oligopoly firms may end up competing so fiercely that they all end up earning zero economic profits—as if they were perfect competitors.

The Prisoner’s Dilemma

Because of the complexity of oligopoly, which is the result of mutual interdependence among firms, there is no single, generally-accepted theory of how oligopolies behave, in the same way that we have theories for all the other market structures. Instead, economists use game theory , a branch of mathematics that analyzes situations in which players must make decisions and then receive payoffs based on what other players decide to do. Game theory has found widespread applications in the social sciences, as well as in business, law, and military strategy.

The prisoner’s dilemma is a scenario in which the gains from cooperation are larger than the rewards from pursuing self-interest. It applies well to oligopoly. The story behind the prisoner’s dilemma goes like this:

Two co-conspiratorial criminals are arrested. When they are taken to the police station, they refuse to say anything and are put in separate interrogation rooms. Eventually, a police officer enters the room where Prisoner A is being held and says: “You know what? Your partner in the other room is confessing. So your partner is going to get a light prison sentence of just one year, and because you’re remaining silent, the judge is going to stick you with eight years in prison. Why don’t you get smart? If you confess, too, we’ll cut your jail time down to five years, and your partner will get five years, also.” Over in the next room, another police officer is giving exactly the same speech to Prisoner B. What the police officers do not say is that if both prisoners remain silent, the evidence against them is not especially strong, and the prisoners will end up with only two years in jail each.

The game theory situation facing the two prisoners is shown in Table 3 . To understand the dilemma, first consider the choices from Prisoner A’s point of view. If A believes that B will confess, then A ought to confess, too, so as to not get stuck with the eight years in prison. But if A believes that B will not confess, then A will be tempted to act selfishly and confess, so as to serve only one year. The key point is that A has an incentive to confess regardless of what choice B makes! B faces the same set of choices, and thus will have an incentive to confess regardless of what choice A makes. Confess is considered the dominant strategy or the strategy an individual (or firm) will pursue regardless of the other individual’s (or firm’s) decision. The result is that if prisoners pursue their own self-interest, both are likely to confess, and end up doing a total of 10 years of jail time between them.

The game is called a dilemma because if the two prisoners had cooperated by both remaining silent, they would only have had to serve a total of four years of jail time between them. If the two prisoners can work out some way of cooperating so that neither one will confess, they will both be better off than if they each follow their own individual self-interest, which in this case leads straight into longer jail terms.

The Oligopoly Version of the Prisoner’s Dilemma

The members of an oligopoly can face a prisoner’s dilemma, also. If each of the oligopolists cooperates in holding down output, then high monopoly profits are possible. Each oligopolist, however, must worry that while it is holding down output, other firms are taking advantage of the high price by raising output and earning higher profits. Table 4 shows the prisoner’s dilemma for a two-firm oligopoly—known as a duopoly . If Firms A and B both agree to hold down output, they are acting together as a monopoly and will each earn $1,000 in profits. However, both firms’ dominant strategy is to increase output, in which case each will earn $400 in profits.

Can the two firms trust each other? Consider the situation of Firm A:

• If A thinks that B will cheat on their agreement and increase output, then A will increase output, too, because for A the profit of $400 when both firms increase output (the bottom right-hand choice in Table 4 ) is better than a profit of only $200 if A keeps output low and B raises output (the upper right-hand choice in the table).
• If A thinks that B will cooperate by holding down output, then A may seize the opportunity to earn higher profits by raising output. After all, if B is going to hold down output, then A can earn $1,500 in profits by expanding output (the bottom left-hand choice in the table) compared with only $1,000 by holding down output as well (the upper left-hand choice in the table).

Thus, firm A will reason that it makes sense to expand output if B holds down output and that it also makes sense to expand output if B raises output. Again, B faces a parallel set of decisions.

The result of this prisoner’s dilemma is often that even though A and B could make the highest combined profits by cooperating in producing a lower level of output and acting like a monopolist, the two firms may well end up in a situation where they each increase output and earn only $400 each in profits . The following Clear It Up feature discusses one cartel scandal in particular.

What is the Lysine cartel?

Lysine, a $600 million-a-year industry, is an amino acid used by farmers as a feed additive to ensure the proper growth of swine and poultry. The primary U.S. producer of lysine is Archer Daniels Midland (ADM), but several other large European and Japanese firms are also in this market. For a time in the first half of the 1990s, the world’s major lysine producers met together in hotel conference rooms and decided exactly how much each firm would sell and what it would charge. The U.S. Federal Bureau of Investigation (FBI), however, had learned of the cartel and placed wire taps on a number of their phone calls and meetings.

From FBI surveillance tapes, following is a comment that Terry Wilson, president of the corn processing division at ADM, made to the other lysine producers at a 1994 meeting in Mona, Hawaii:

I wanna go back and I wanna say something very simple. If we’re going to trust each other, okay, and if I’m assured that I’m gonna get 67,000 tons by the year’s end, we’re gonna sell it at the prices we agreed to . . . The only thing we need to talk about there because we are gonna get manipulated by these [expletive] buyers—they can be smarter than us if we let them be smarter. . . . They [the customers] are not your friend. They are not my friend. And we gotta have ‘em, but they are not my friends. You are my friend. I wanna be closer to you than I am to any customer. Cause you can make us … money. … And all I wanna tell you again is let’s—let’s put the prices on the board. Let’s all agree that’s what we’re gonna do and then walk out of here and do it.

The price of lysine doubled while the cartel was in effect. Confronted by the FBI tapes, Archer Daniels Midland pled guilty in 1996 and paid a fine of $100 million. A number of top executives, both at ADM and other firms, later paid fines of up to $350,000 and were sentenced to 24–30 months in prison.

In another one of the FBI recordings, the president of Archer Daniels Midland told an executive from another competing firm that ADM had a slogan that, in his words, had “penetrated the whole company.” The company president stated the slogan this way: “Our competitors are our friends. Our customers are the enemy.” That slogan could stand as the motto of cartels everywhere.

How to Enforce Cooperation

How can parties who find themselves in a prisoner’s dilemma situation avoid the undesired outcome and cooperate with each other? The way out of a prisoner’s dilemma is to find a way to penalize those who do not cooperate.

Perhaps the easiest approach for colluding oligopolists, as you might imagine, would be to sign a contract with each other that they will hold output low and keep prices high. If a group of U.S. companies signed such a contract, however, it would be illegal. Certain international organizations, like the nations that are members of the Organization of Petroleum Exporting Countries (OPEC) , have signed international agreements to act like a monopoly, hold down output, and keep prices high so that all of the countries can make high profits from oil exports. Such agreements, however, because they fall in a gray area of international law, are not legally enforceable. If Nigeria, for example, decides to start cutting prices and selling more oil, Saudi Arabia cannot sue Nigeria in court and force it to stop.

Visit the Organization of the Petroleum Exporting Countries website and learn more about its history and how it defines itself.

Because oligopolists cannot sign a legally enforceable contract to act like a monopoly, the firms may instead keep close tabs on what other firms are producing and charging. Alternatively, oligopolists may choose to act in a way that generates pressure on each firm to stick to its agreed quantity of output.

One example of the pressure these firms can exert on one another is the kinked demand curve , in which competing oligopoly firms commit to match price cuts, but not price increases. This situation is shown in Figure 1 . Say that an oligopoly airline has agreed with the rest of a cartel to provide a quantity of 10,000 seats on the New York to Los Angeles route, at a price of $500. This choice defines the kink in the firm’s perceived demand curve. The reason that the firm faces a kink in its demand curve is because of how the other oligopolists react to changes in the firm’s price. If the oligopoly decides to produce more and cut its price, the other members of the cartel will immediately match any price cuts—and therefore, a lower price brings very little increase in quantity sold.

If one firm cuts its price to $300, it will be able to sell only 11,000 seats. However, if the airline seeks to raise prices, the other oligopolists will not raise their prices, and so the firm that raised prices will lose a considerable share of sales. For example, if the firm raises its price to $550, its sales drop to 5,000 seats sold. Thus, if oligopolists always match price cuts by other firms in the cartel, but do not match price increases, then none of the oligopolists will have a strong incentive to change prices, since the potential gains are minimal. This strategy can work like a silent form of cooperation, in which the cartel successfully manages to hold down output, increase price , and share a monopoly level of profits even without any legally enforceable agreement.

Many real-world oligopolies, prodded by economic changes, legal and political pressures, and the egos of their top executives, go through episodes of cooperation and competition. If oligopolies could sustain cooperation with each other on output and pricing, they could earn profits as if they were a single monopoly. However, each firm in an oligopoly has an incentive to produce more and grab a bigger share of the overall market; when firms start behaving in this way, the market outcome in terms of prices and quantity can be similar to that of a highly competitive market.

Tradeoffs of Imperfect Competition

Monopolistic competition is probably the single most common market structure in the U.S. economy. It provides powerful incentives for innovation, as firms seek to earn profits in the short run, while entry assures that firms do not earn economic profits in the long run. However, monopolistically competitive firms do not produce at the lowest point on their average cost curves. In addition, the endless search to impress consumers through product differentiation may lead to excessive social expenses on advertising and marketing.

Oligopoly is probably the second most common market structure. When oligopolies result from patented innovations or from taking advantage of economies of scale to produce at low average cost, they may provide considerable benefit to consumers. Oligopolies are often buffeted by significant barriers to entry, which enable the oligopolists to earn sustained profits over long periods of time. Oligopolists also do not typically produce at the minimum of their average cost curves. When they lack vibrant competition, they may lack incentives to provide innovative products and high-quality service.

The task of public policy with regard to competition is to sort through these multiple realities, attempting to encourage behavior that is beneficial to the broader society and to discourage behavior that only adds to the profits of a few large companies, with no corresponding benefit to consumers. Monopoly and Antitrust Policy discusses the delicate judgments that go into this task.

The Temptation to Defy the Law

Oligopolistic firms have been called “cats in a bag,” as this chapter mentioned. The French detergent makers chose to “cozy up” with each other. The result? An uneasy and tenuous relationship. When the Wall Street Journal reported on the matter, it wrote: “According to a statement a Henkel manager made to the [French anti-trust] commission, the detergent makers wanted ‘to limit the intensity of the competition between them and clean up the market.’ Nevertheless, by the early 1990s, a price war had broken out among them.” During the soap executives’ meetings, which sometimes lasted more than four hours, complex pricing structures were established. “One [soap] executive recalled ‘chaotic’ meetings as each side tried to work out how the other had bent the rules.” Like many cartels, the soap cartel disintegrated due to the very strong temptation for each member to maximize its own individual profits.

How did this soap opera end? After an investigation, French antitrust authorities fined Colgate-Palmolive, Henkel, and Proctor & Gamble a total of €361 million ($484 million). A similar fate befell the icemakers. Bagged ice is a commodity, a perfect substitute, generally sold in 7- or 22-pound bags. No one cares what label is on the bag. By agreeing to carve up the ice market, control broad geographic swaths of territory, and set prices, the icemakers moved from perfect competition to a monopoly model. After the agreements, each firm was the sole supplier of bagged ice to a region; there were profits in both the long run and the short run. According to the courts: “These companies illegally conspired to manipulate the marketplace.” Fines totaled about $600,000—a steep fine considering a bag of ice sells for under $3 in most parts of the United States.

Even though it is illegal in many parts of the world for firms to set prices and carve up a market, the temptation to earn higher profits makes it extremely tempting to defy the law.

Key Concepts and Summary

An oligopoly is a situation where a few firms sell most or all of the goods in a market. Oligopolists earn their highest profits if they can band together as a cartel and act like a monopolist by reducing output and raising price. Since each member of the oligopoly can benefit individually from expanding output, such collusion often breaks down—especially since explicit collusion is illegal.

The prisoner’s dilemma is an example of game theory. It shows how, in certain situations, all sides can benefit from cooperative behavior rather than self-interested behavior. However, the challenge for the parties is to find ways to encourage cooperative behavior.

Self-Check Questions

• Suppose the firms collude to form a cartel. What price will the cartel charge? What quantity will the cartel supply? How much profit will the cartel earn?
• Suppose now that the cartel breaks up and the oligopolistic firms compete as vigorously as possible by cutting the price and increasing sales. What will the industry quantity and price be? What will the collective profits be of all firms in the industry?
• Compare the equilibrium price, quantity, and profit for the cartel and cutthroat competition outcomes.

Review Questions

• Will the firms in an oligopoly act more like a monopoly or more like competitors? Briefly explain.
• Does each individual in a prisoner’s dilemma benefit more from cooperation or from pursuing self-interest? Explain briefly.
• What stops oligopolists from acting together as a monopolist and earning the highest possible level of profits?

Critical Thinking Questions

• Would you expect the kinked demand curve to be more extreme (like a right angle) or less extreme (like a normal demand curve) if each firm in the cartel produces a near-identical product like OPEC and petroleum? What if each firm produces a somewhat different product? Explain your reasoning.
• When OPEC raised the price of oil dramatically in the mid-1970s, experts said it was unlikely that the cartel could stay together over the long term—that the incentives for individual members to cheat would become too strong. More than forty years later, OPEC still exists. Why do you think OPEC has been able to beat the odds and continue to collude? Hint: You may wish to consider non-economic reasons.
• Mary and Raj are the only two growers who provide organically grown corn to a local grocery store. They know that if they cooperated and produced less corn, they could raise the price of the corn. If they work independently, they will each earn $100. If they decide to work together and both lower their output, they can each earn $150. If one person lowers output and the other does not, the person who lowers output will earn $0 and the other person will capture the entire market and will earn $200. Table 6 represents the choices available to Mary and Raj. What is the best choice for Raj if he is sure that Mary will cooperate? If Mary thinks Raj will cheat, what should Mary do and why? What is the prisoner’s dilemma result? What is the preferred choice if they could ensure cooperation? A = Work independently; B = Cooperate and Lower Output. (Each results entry lists Raj’s earnings first, and Mary’s earnings second.)

The United States Department of Justice. “Antitrust Division.” Accessed October 17, 2013. http://www.justice.gov/atr/.

eMarketer.com. 2014. “Total US Ad Spending to See Largest Increase Since 2004: Mobile advertising leads growth; will surpass radio, magazines and newspapers this year. Accessed March 12, 2015. http://www.emarketer.com/Article/Total-US-Ad-Spending-See-Largest-Increase-Since-2004/1010982.

Federal Trade Commission. “About the Federal Trade Commission.” Accessed October 17, 2013. http://www.ftc.gov/ftc/about.shtm.

Answers to Self-Check Questions

• Pc > Pcc. Qc < Qcc. Profit for the cartel is positive and large. Profit for cutthroat competition is zero.
• Firm B reasons that if it cheats and Firm A does not notice, it will double its money. Since Firm A’s profits will decline substantially, however, it is likely that Firm A will notice and if so, Firm A will cheat also, with the result that Firm B will lose 90% of what it gained by cheating. Firm A will reason that Firm B is unlikely to risk cheating. If neither firm cheats, Firm A earns $1000. If Firm A cheats, assuming Firm B does not cheat, A can boost its profits only a little, since Firm B is so small. If both firms cheat, then Firm A loses at least 50% of what it could have earned. The possibility of a small gain ($50) is probably not enough to induce Firm A to cheat, so in this case it is likely that both firms will collude.

Principles of Economics Copyright © 2016 by Rice University is licensed under a Creative Commons Attribution 4.0 International License , except where otherwise noted.

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10 Oligopoly

10.1 theory of the oligopoly, why do oligopolies exist.

Many purchases that individuals make at the retail level are produced in markets that are neither perfectly competitive, monopolies, nor monopolistically competitive. Rather, they are oligopolies. Oligopoly arises when a small number of large firms have all or most of the sales in an industry. Examples of oligopoly abound and include the auto industry, cable television, and commercial air travel. Oligopolistic firms are like cats in a bag. They can either scratch each other to pieces or cuddle up and get comfortable with one another. If oligopolists compete hard, they may end up acting very much like perfect competitors, driving down costs and leading to zero profits for all. If oligopolists collude with each other, they may effectively act like a monopoly and succeed in pushing up prices and earning consistently high levels of profit. We typically characterize oligopolies by mutual interdependence where various decisions such as output, price, and advertising depend on other firm(s)’ decisions. Analyzing the choices of oligopolistic firms about pricing and quantity produced involves considering the pros and cons of competition versus collusion at a given point in time.

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.

Similarly, 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 (also called a duopoly) for large passenger aircraft.

The product differentiation at the heart of monopolistic competition can also play a role in creating oligopoly. For example, firms may need to reach a certain minimum size before they are able to spend enough on advertising and marketing to create a recognizable brand name. The problem in competing with, say, Coca-Cola or Pepsi is not that producing fizzy drinks is technologically difficult, but rather that creating a brand name and marketing effort to equal Coke or Pepsi is an enormous task.

The existence of oligopolies can lead to the combination of many firms into larger firms. This is discussed next.

Types of Firm Integration

Conglomerate.

From: Wikipedia: Conglomerate (company)

A  conglomerate  is a combination of multiple  business entities  operating in entirely different industries under one  corporate group , usually involving a  parent company  and many  subsidiaries . Often, a conglomerate is a  multi-industry company . Conglomerates are often large and  multinational .

Horizontal Integration

From: Wikipedia: Horizontal integration

Horizontal integration  is the process of a  company  increasing  production  of goods or services at the same part of the  supply chain . A company may do this via internal expansion,  acquisition or merger . [1] [2] [3]

The process can lead to  monopoly  if a company captures the vast majority of the market for that product or service. [3]

Horizontal integration contrasts with  vertical integration , where companies integrate multiple stages of production of a small number of production units.

Benefits of horizontal integration to both the firm and society may include  economies of scale  and  economies of scope . For the firm, horizontal integration may provide a strengthened presence in the reference market. It may also allow the horizontally integrated firm to engage in  monopoly pricing , which is disadvantageous to society as a whole and which may cause regulators to ban or constrain horizontal integration. [5]

An example of horizontal integration in the food industry was the  Heinz  and  Kraft Foods  merger. On March 25, 2015, Heinz and Kraft merged into one company, the deal valued at $46 Billion. [8] [9]  Both produce processed food for the consumer market.

On November 16, 2015,  Marriott International  announced that it would purchase  Starwood Hotels  for $13.6 billion, creating the world’s largest hotel chain once the deal closed. [11]  The merger was finalized on September 23, 2016. [12]

AB-Inbev acquisition of SAB Miller for $107 Billion which completed in 2016, is one of the biggest deals of all time. [13]

Vertical Integration

From: Wikipedia: Vertical integration

In  microeconomics  and  management ,  vertical integration  is an arrangement in which the  supply chain  of a company is owned by that company. Usually each member of the supply chain produces a different  product  or (market-specific) service, and the products combine to satisfy a common need. It is contrasted with  horizontal integration , wherein a company produces several items which are related to one another. Vertical integration has also described  management styles  that bring large portions of the supply chain not only under a common ownership, but also into one  corporation  (as in the 1920s when the  Ford River Rouge Complex  began making much of its own steel rather than buying it from suppliers).

Vertical integration and expansion is desired because it secures the supplies needed by the firm to produce its product and the market needed to sell the product. Vertical integration and expansion can become undesirable when its actions become anti-competitive and impede free competition in an open marketplace. Vertical integration is one method of avoiding the  hold-up problem . A monopoly produced through vertical integration is called a  vertical monopoly .

Vertical integration is often closely associated to vertical expansion which, in  economics , is the growth of a business enterprise through the  acquisition  of companies that produce the intermediate goods needed by the business or help market and distribute its product. Such expansion is desired because it secures the supplies needed by the  firm  to produce its product and the market needed to sell the product. Such expansion can become undesirable when its actions become  anti-competitive  and impede free competition in an open marketplace.

The result is a more efficient business with lower costs and more profits. On the undesirable side, when vertical expansion leads toward  monopolistic  control of a product or service then regulative action may be required to rectify anti-competitive behavior. Related to vertical expansion is  lateral expansion , which is the growth of a business enterprise through the acquisition of similar firms, in the hope of achieving  economies of scale .

Vertical expansion is also known as a vertical acquisition. Vertical expansion or acquisitions can also be used to increase scales and to gain market power. The acquisition of  DirecTV  by  News Corporation  is an example of forward vertical expansion or acquisition. DirecTV is a  satellite TV  company through which News Corporation can distribute more of its media content: news, movies and television shows. The acquisition of  NBC  by  Comcast  is an example of backward vertical integration. For example, in the United States, protecting the public from communications monopolies that can be built in this way is one of the missions of the  Federal Communications Commission .

One of the earliest, largest and most famous examples of vertical integration was the  Carnegie Steel  company. The company controlled not only the mills where the  steel  was made, but also the mines where the  iron ore  was extracted, the coal mines that supplied the  coal , the ships that transported the iron ore and the railroads that transported the coal to the factory, the  coke  ovens where the coal was cooked, etc. The company focused heavily on developing talent internally from the bottom up, rather than importing it from other companies. Later, Carnegie established  an institute  of higher learning to teach the steel processes to the next generation.

Oil companies , both multinational (such as  ExxonMobil ,  Royal Dutch Shell ,  ConocoPhillips  or  BP ) and national (e.g.,  Petronas ) often adopt a vertically integrated structure, meaning that they are active along the entire supply chain from  locating deposits , drilling and extracting  crude oil , transporting it around the world,  refining  it into petroleum products such as  petrol/gasoline , to distributing the fuel to company-owned retail stations, for sale to consumers.

Lateral Integration

Lateral expansion , in  economics , is the growth of a business enterprise through the acquisition of similar companies, in the hope of achieving  economies of scale  or  economies of scope . Unchecked lateral expansion can lead to powerful  conglomerates  or  monopolies .

Lateral integration differs from horizontal integration as the integration is not exact. For example, one of the examples of horizontal integration was one hotel chain buying another. This did not enhance the company’s product offerings other than having more hotel options.

On the other hand, Parker Hannifin acquired Lord Corporation. While the two companies make similar types of products, their product offerings were distinct. There was not much overlap with the types of products offered. Instead, Parker Hannifin was not able to provide a far greater product offering in the given sectors.

The Strength of an Oligopoly

From: Wikipedia: Concentration ratio

The most common concentration ratios are the CR 4  and the CR 8 , which means the market share of the four and the eight largest firms. Concentration ratios are usually used to show the extent of market control of the largest firms in the industry and to illustrate the degree to which an industry is  oligopolistic . [1]

N-firm concentration ratio is a common measure of market structure and shows the combined market share of the N largest firms in the market. For example, the 5-firm concentration ratio in the UK pesticide industry is 0.75, which indicates that the combined market share of the five largest pesticide sellers in the UK is about 75%. N-firm concentration ratio does not reflect changes in the size of the largest firms.

Concentration ratios range from 0 to 100 percent. The levels reach from  no, low  or  medium  to  high  to “total” concentration

Perfect competition

If there are  N  firms in an industry and we are looking at the top  n  of them, equal market share for all of them means that CR n  =  n/N . All other possible values will be greater than this.

No concentration

If CR n  is close to 0%, (which is only possible for quite a large number of firms in the industry  N ) this means  perfect competition  or at the very least  monopolistic competition . If for example CR 4 =0 %, the four largest firm in the industry would not have any significant market share.

Low concentration

0% to 40%. [5]  This category ranges from perfect competition to an oligopoly.

Medium concentration

40% to 70%. [5]  An industry in this range is likely an oligopoly.

High concentration

70% to 100%. [5]  This category ranges from an oligopoly to monopoly.

Total concentration

100% means an extremely concentrated  oligopoly . If for example CR 1 = 100%, there is a  monopoly .

10.2 Game theory

Game theory basics, dominant versus non-dominant strategies.

From: Wikipedia: Cooperative game theory

In game theory , a cooperative game (or coalitional game ) is a game with competition between groups of players (“coalitions”) due to the possibility of external enforcement of cooperative behavior (e.g. through contract law ). Those are opposed to non-cooperative games in which there is either no possibility to forge alliances or all agreements need to be self-enforcing (e.g. through credible threats ). [1]

Cooperative games are often analysed through the framework of cooperative game theory, which focuses on predicting which coalitions will form, the joint actions that groups take and the resulting collective payoffs. It is opposed to the traditional non-cooperative game theory which focuses on predicting individual players’ actions and payoffs and analyzing Nash equilibria . [2] [3]

Cooperative game theory provides a high-level approach as it only describes the structure, strategies and payoffs of coalitions, whereas non-cooperative game theory also looks at how bargaining procedures will affect the distribution of payoffs within each coalition. As non-cooperative game theory is more general, cooperative games can be analyzed through the approach of non-cooperative game theory (the converse does not hold) provided that sufficient assumptions are made to encompass all the possible strategies available to players due to the possibility of external enforcement of cooperation. While it would thus be possible to have all games expressed under a non-cooperative framework, in many instances insufficient information is available to accurately model the formal procedures available to the players during the strategic bargaining process, or the resulting model would be of too high complexity to offer a practical tool in the real world. In such cases, cooperative game theory provides a simplified approach that allows the analysis of the game at large without having to make any assumption about bargaining powers.

Types of Strategies

General strategy.

This is simply any rule that a player uses. These strategies can be “good” or “bad.” For example, if you have to choose heads or tails for a coinflip, you may use the strategy “tails never fails” and always pick tails even though there is no advantage to this strategy. Additionally, when playing the game of Blackjack, you may have a rule that you always hit when you have a score of 20. If you do not know how to play Blackjack, I will simply state that this is generally a very, very bad idea! Even though it is a poor strategy, it is still a strategy nonetheless.

Dominant Strategy

From: Wikipedia: Strategic dominance

In game theory , strategic dominance (commonly called simply dominance ) occurs when one strategy is better than another strategy for one player, no matter how that player’s opponents may play. Many simple games can be solved using dominance.

Nash Equilibrium

From: Wikipedia: Nash equilibrium

In terms of game theory, if each player has chosen a strategy, and no player can benefit by changing strategies while the other players keep theirs unchanged, then the current set of strategy choices and their corresponding payoffs constitutes a Nash equilibrium.

Stated simply, Alice and Bob are in Nash equilibrium if Alice is making the best decision she can, taking into account Bob’s decision while his decision remains unchanged, and Bob is making the best decision he can, taking into account Alice’s decision while her decision remains unchanged. Likewise, a group of players are in Nash equilibrium if each one is making the best decision possible, taking into account the decisions of the others in the game as long as the other parties’ decisions remain unchanged.

Informally, a strategy profile is a Nash equilibrium if no player can do better by unilaterally changing his or her strategy. To see what this means, imagine that each player is told the strategies of the others. Suppose then that each player asks themselves: “Knowing the strategies of the other players, and treating the strategies of the other players as set in stone, can I benefit by changing my strategy?”

If any player could answer “Yes”, then that set of strategies is not a Nash equilibrium. But if every player prefers not to switch (or is indifferent between switching and not) then the strategy profile is a Nash equilibrium. Thus, each strategy in a Nash equilibrium is a best response to all other strategies in that equilibrium. [13]

The Nash equilibrium may sometimes appear non-rational in a third-person perspective. This is because a Nash equilibrium is not necessarily Pareto optimal . [Note: We do not talk about Pareto optimality in this class, but you can think of it as a best-case for everyone situation.]

The Prisoner’s Dilemma

From: Wikipedia: Prisoner’s dilemma

The prisoner’s dilemma is a standard example of a game analyzed in game theory that shows why two completely rational individuals might not cooperate, even if it appears that it is in their best interests to do so. It was originally framed by Merrill Flood and Melvin Dresher while working at RAND in 1950. Albert W. Tucker formalized the game with prison sentence rewards and named it “prisoner’s dilemma”, [1] presenting it as follows:

Two members of a criminal gang are arrested and imprisoned. Each prisoner is in solitary confinement with no means of communicating with the other. The prosecutors lack sufficient evidence to convict the pair on the principal charge, but they have enough to convict both on a lesser charge. Simultaneously, the prosecutors offer each prisoner a bargain. Each prisoner is given the opportunity either to betray the other by testifying that the other committed the crime, or to cooperate with the other by remaining silent. The offer is: If A and B each betray the other, each of them serves two years in prison If A betrays B but B remains silent, A will be set free and B will serve three years in prison (and vice versa) If A and B both remain silent, both of them will serve only one year in prison (on the lesser charge).

It is implied that the prisoners will have no opportunity to reward or punish their partner other than the prison sentences they get and that their decision will not affect their reputation in the future. Because betraying a partner offers a greater reward than cooperating with them, all purely rational self-interested prisoners will betray the other, meaning the only possible outcome for two purely rational prisoners is for them to betray each other. [2] The interesting part of this result is that pursuing individual reward logically leads both of the prisoners to betray when they would get a better individual reward if they both kept silent. In reality, humans display a systemic bias towards cooperative behavior in this and similar games despite what is predicted by simple models of “rational” self-interested action. [3] [4] [5] [6] This bias towards cooperation has been known since the test was first conducted at RAND; the secretaries involved trusted each other and worked together for the best common outcome. [7]

The prisoner’s dilemma game can be used as a model for many real world situations involving cooperative behavior. In casual usage, the label “prisoner’s dilemma” may be applied to situations not strictly matching the formal criteria of the classic or iterative games: for instance, those in which two entities could gain important benefits from cooperating or suffer from the failure to do so, but find it difficult or expensive—not necessarily impossible—to coordinate their activities.

Game Tables

In the game above, we need some way to display all of the information in a condensed format. To accomplish this, we use a game table. For the sake of displaying the game tables in an accessible manner, I will use the following format:

You will see that the information is exactly the same as the information presented. For example, if A stays silent, but B betrays, we would be in the top, right payout cell (which is -3,0).

The next question is what the “best” outcome is. We will examine that but going back to the two strategies discussed earlier.

Solving Prisoner’s Dilemma with Dominant Strategy

The iterated elimination (or deletion) of dominated strategies (also denominated as IESDS or IDSDS) is one common technique for solving games that involves iteratively removing dominated strategies. In the first step, at most one dominated strategy is removed from the strategy space of each of the players since no rational player would ever play these strategies. This results in a new, smaller game. Some strategies—that were not dominated before—may be dominated in the smaller game. The first step is repeated, creating a new even smaller game, and so on. The process stops when no dominated strategy is found for any player. This process is valid since it is assumed that rationality among players is common knowledge , that is, each player knows that the rest of the players are rational, and each player knows that the rest of the players know that he knows that the rest of the players are rational, and so on ad infinitum (see Aumann, 1976).

There are two versions of this process. One version involves only eliminating strictly dominated strategies. If, after completing this process, there is only one strategy for each player remaining, that strategy set is the unique Nash equilibrium [2] . This will be discussed next.

You can use the following set of steps:

• Pick one person (it doesn’t matter).
• If their opponent picks choice A, what will your person pick?
• If their opponent picks choice B, what will your person pick?
• If you choose the same thing for both of your opponent’s choices, then that is the dominant strategy. We say that choice strictly dominates the other choice and you can cross off the strictly dominated strategy.
• Repeat for the opponent (this should be easier).
• If the choices are different, there is no dominant strategy

Let us return to the prisoner’s dilemma game table. Let us act as player A and decide what player A would do in a variety of situations.

If player B stays silent, what should we do as player A? If we stay silent, then we would lose 1 (meaning one year in prison.) If we betray, we earn 0. In this case we should betray as no prison is better than one year in prison.

If player B betrays, what should we do as player A? If we stay silent, then we get three years in prison. If we betray, we get two years in prison. In this case, we should betray as two years in prison is better than 3 years in prison.

Therefore, the dominant strategy for player A is to betray. This is because regardless of what player B chooses to do, player A’s best choice is to betray. We can therefore eliminate “A-stay silent” since player A will not stay silent.

We can now move to player B to see if there is a dominant strategy for player B. It should be noted that, in theory, there does not need to be, but with our games there will be (if player A has one.) So, now let us play our modified game as player B.

If player A chooses to stay silent – STOP! – what did we just discuss? Player A will not choose to stay silent, so we do not need to worry about this. So, if player A chooses to betray, what should we do as player B? If we stay silent, we get three years in prison whereas we only get two years in prison if we betray. Therefore, player B should betray.

Thus, the dominant strategy for this game is (A,B)=(Betray,Betray).

There are additional exercises in the companion. Each player can have either 0 or 1 dominant strategies.

Solving Prisoner’s Dilemma with Nash Equilibrium

As mentioned earlier, we are looking for a stable solution. That is, a situation where neither player has an incentive to change their choice based on the other player’s choice. To find the Nash Equilibrium, you can follow these steps:

• Choose a player (again, it doesn’t matter which).
• Pick a choice (it doesn’t matter which).
• Based on your choice, what will the opponent pick?
• Based on what your opponent picks, what would you pick?
• If it is the same as your original choice, it is a Nash Equilibrium. If not, it is not a Nash Equilibrium.
• Repeat for the other choice(s).

So, let us return to our game. Without loss of generality, let us play as player A. It should be noted that playing as player B will yield the same exact results.

As player A, let us begin by staying silent. What will player B do? Player B can either stay silent (one year in prison) or betray (0 years in prison.) Player B will betray. Now, since we know that player B will betray, what should player A do? If player A stays silent, we get 3 years in prison but if we betray we only get two years in prison. Thus, we, as player A, should betray. But this is different from where we started, thus we do not have a Nash Equilibrium. The chain for this event is:

A: Silent >> B: Betray >> A: Betray — A has changed their choice, not a Nash Equilibrium.

Now, as player A, let us start by betraying. If we betray, player B can either stay silent (3 years in prison) or betray (2 years in prison.) Thus, player B will betray. When player B betrays, what should we do? We can either stay silent (3 years in prison) or betray (2 years in prison.) Thus, we betray. This is exactly where we started, thus, we have a Nash Equilibrium. In fact, we could continue to do this forever and the chain would stay exactly the same. The chain for this scenario is:

A: Betray >> B: Betray >> A: Betray — A has kept their choice the same, so A:Betray, B:Betray is a Nash Equilibrium.

10.3 Cartels and Collusion

Game theory and oligopolies.

So what was the foray into game theory for? It allows us to explore how individual firms in oligopolies want to act. Let us consider two firms that each produce widgets. They can each choose to either produce at a high price level or low price level. Remember, for a firm to produce more (and sell it) they have to charge less. And if a firm restricts its output, they can charge more. Recall, a monopolist is able to make an additional profit because it restricts output and charges more whereas a firm in a perfectly competitive market may sell more, but at a lower price, and therefore earns a lower profit.

Let us use the following game table showing each firms’ profits:

First, let us step back and just look at the game table. What should each firm do? It seems like each firm should just set their price high. But, is that what will happen?

Let us look for the dominant strategy. As player A, if player B chooses to set a high price, we should should charge a low price (70>65). If player B chooses to set a low price, we should choose low price (40>20). Therefore, as player A, we should always choose to set our price low. The same applies for player B as setting their price low is always better than setting their price high regardless of what player A does (100>90 and 60>40).

So, even though it “makes sense” for both firms to set their prices high, both firms will set their prices low. The same would apply to the Nash Equilibrium.

What does this mean in the real world? If the two firms could cooperate and fully trust each other, they would each set their prices high. This is what we call collusion and will be discussed shortly. But, whether it is due to laws or just human nature, firms are never able to collude too long. Eventually, firms will move to the dominant strategy. While firms would like to keep their prices high, there are typically forces that prevent this.

From: Wikipedia: OPEC

The Organization of the Petroleum Exporting Countries ( OPEC , / ˈ oʊ p ɛ k / OH-pek ) is an intergovernmental organization of 14 nations, founded in 1960 in Baghdad by the first five members ( Iran , Iraq , Kuwait , Saudi Arabia , and Venezuela ), and headquartered since 1965 in Vienna, Austria . As of September 2018, the then 14 member countries accounted for an estimated 44 percent of global oil production and 81.5 percent of the world’s “proven” oil reserves , giving OPEC a major influence on global oil prices that were previously determined by the so called “ Seven Sisters ” grouping of multinational oil companies.

The stated mission of the organization is to “coordinate and unify the petroleum policies of its member countries and ensure the stabilization of oil markets, in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers, and a fair return on capital for those investing in the petroleum industry.” [4] The organization is also a significant provider of information about the international oil market. The current OPEC members are the following: Algeria , Angola , Ecuador , Equatorial Guinea , Gabon , Iran , Iraq , Kuwait , Libya , Nigeria , the Republic of the Congo , Saudi Arabia (the de facto leader), United Arab Emirates , and Venezuela . Indonesia and Qatar are former members.

The formation of OPEC marked a turning point toward national sovereignty over natural resources , and OPEC decisions have come to play a prominent role in the global oil market and international relations . The effect can be particularly strong when wars or civil disorders lead to extended interruptions in supply. In the 1970s, restrictions in oil production led to a dramatic rise in oil prices and in the revenue and wealth of OPEC, with long-lasting and far-reaching consequences for the global economy . In the 1980s, OPEC began setting production targets for its member nations; generally, when the targets are reduced, oil prices increase. This has occurred most recently from the organization’s 2008 and 2016 decisions to trim oversupply.

Economists often cite OPEC as a textbook example of a cartel that cooperates to reduce market competition , but one whose consultations are protected by the doctrine of state immunity under international law . In December 2014, “OPEC and the oil men” ranked as #3 on Lloyd’s list of “the top 100 most influential people in the shipping industry”. [5] However, the influence of OPEC on international trade is periodically challenged by the expansion of non-OPEC energy sources, and by the recurring temptation for individual OPEC countries to exceed production targets and pursue conflicting self-interests.

At various times, OPEC members have displayed apparent anti-competitive cartel behavior through the organization’s agreements about oil production and price levels. [26] In fact, economists often cite OPEC as a textbook example of a cartel that cooperates to reduce market competition, as in this definition from OECD ‘s Glossary of Industrial Organisation Economics and Competition Law : [1]

International commodity agreements covering products such as coffee, sugar, tin and more recently oil (OPEC: Organization of Petroleum Exporting Countries) are examples of international cartels which have publicly entailed agreements between different national governments.

OPEC members strongly prefer to describe their organization as a modest force for market stabilization, rather than a powerful anti-competitive cartel. In its defense, the organization was founded as a counterweight against the previous “ Seven Sisters ” cartel of multinational oil companies, and non-OPEC energy suppliers have maintained enough market share for a substantial degree of worldwide competition. [27] Moreover, because of an economic “ prisoner’s dilemma ” that encourages each member nation individually to discount its price and exceed its production quota, [28] widespread cheating within OPEC often erodes its ability to influence global oil prices through collective action . [29] [30]

OPEC has not been involved in any disputes related to the competition rules of the World Trade Organization , even though the objectives, actions, and principles of the two organizations diverge considerably. [31] A key US District Court decision held that OPEC consultations are protected as “governmental” acts of state by the Foreign Sovereign Immunities Act , and are therefore beyond the legal reach of US competition law governing “commercial” acts. [32] [33] Despite popular sentiment against OPEC, legislative proposals to limit the organization’s sovereign immunity, such as the NOPEC Act, have so far been unsuccessful. [34]

Cartel Theory

From: Wikipedia: Cartel

A cartel is a group of apparently independent producers whose goal is to increase their collective profits by means of price fixing , limiting supply, or other restrictive practices . Cartels typically control selling prices, but some are organized to force down the prices of purchased inputs. Antitrust laws attempt to deter or forbid cartels. A single entity that holds a monopoly by this definition cannot be a cartel, though it may be guilty of abusing said monopoly in other ways. Cartels usually arise in oligopolies —industries with a small number of sellers—and usually involve homogeneous products .

A survey of hundreds of published economic studies and legal decisions of antitrust authorities found that the median price increase achieved by cartels in the last 200 years is about 23 percent. [4] Private international cartels (those with participants from two or more nations) had an average price increase of 28 percent, whereas domestic cartels averaged 18 percent. Less than 10 percent of all cartels in the sample failed to raise market prices.

In general, cartel agreements are economically unstable in that there is an incentive for members to cheat by selling at below the agreed price or selling more than the production quotas set by the cartel (see also game theory ). This has caused many cartels that attempt to set product prices to be unsuccessful in the long term . Empirical studies of 20th-century cartels have determined that the mean duration of discovered cartels is from 5 to 8 years [5] . However, once a cartel is broken, the incentives to form the cartel return and the cartel may be re-formed. Publicly known cartels that do not follow this cycle include, by some accounts, the Organization of the Petroleum Exporting Countries (OPEC).

Price fixing is often practiced internationally. When the agreement to control price is sanctioned by a multilateral treaty or protected by national sovereignty, no antitrust actions may be initiated [6] . Examples of such price fixing include oil, whose price is partly controlled by the supply by OPEC countries, and international airline tickets, which have prices fixed by agreement with the IATA , a practice for which there is a specific exception in antitrust law.

Prior to World War II (except in the United States), members of cartels could sign contracts that were enforceable in courts of law. There were even instances where cartels are encouraged by states. For example, during the period before 1945, cartels were tolerated in Europe and were promoted as a business practice in German-speaking countries. [7] This was the norm due to the accepted benefits, which even the U.S. Supreme court has noted. In the case, the U.S. v. National Lead Co. et al. , it cited the testimony of individuals, who cited that a cartel, in its protean form, is “a combination of producers for the purpose of regulating production and, frequently, prices, and an association by agreement of companies or sections of companies having common interests so as to prevent extreme or unfair competition.” [8]

Today, however, price fixing by private entities is illegal under the antitrust laws of more than 140 countries. Examples of prosecuted international cartels are lysine , citric acid , graphite electrodes , and bulk vitamins . [9] This is highlighted in countries with market economies wherein price-fixing and the concept of cartels are considered inimical to free and fair competition, which is considered the backbone of political democracy. [10] The current condition makes it increasingly difficult for cartels to maintain sustainable operations. Even if international cartels might be out of reach for the regulatory authorities, they will still have to contend with the fact that their activities in domestic markets will be affected. [11]

For a cartel to be successful, some or all of the following conditions are necessary:

• A small number of firms.
• Products are relatively undifferentiated from one firm to the next.
• Prices are easily observable.
• Prices show little variation over time.

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Imagine you have a company, and it is doing great. You are in an industry where four other companies have a similar market share to yours. There are not many other companies out there that produce what you’re producing, and those that are, are relatively small. To what extent do you think the behaviour of the other four companies will impact the way you price your goods and the amount of output you choose? Would you choose to collude with them and set prices or continue competing if it was feasible?

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This is what oligopoly is all about. In this explanation, you will learn everything you need to know about oligopoly, how firms behave in an oligopolistic market, and whether they always collude or compete.

Oligopoly definition

Oligopoly occurs in industries where few but large leading firms dominate the market. Firms that are part of an oligopolistic market structure can’t prevent other firms from gaining significant dominance in the market. However, as only a few firms have a significant share of the market, each firm’s behaviour can have an impact on the other.

There must be a lower limit of two firms for a market structure to be considered oligopolistic, but there’s no upper limit to how many firms are in the market. It is essential that there are a few and all of them combined have a significant share of the market, which is measured by the concentration ratio.

An oligopoly is a market structure where a few large firms dominate the market.

To learn more about other types of markets as well as how to calculate concentration ratios check our explanation on Market Structures .

The concentration ratio is a tool that measures the market share of the leading companies in an industry. You could have maybe five firms, seven, or even ten. How do you know if it’s an oligopolistic market structure? You have to look at the concentration ratio of the largest firms. If the most dominant firms have a combined concentration ratio of more than 50%, that market is considered an oligopoly. That is to say, an oligopoly is about the dominant firms’ market power in a given industry.

You can usually find typical examples of oligopolistic market structures in oil companies, supermarket chains, and the pharmaceutical industry.

When companies gain high collective market power, they can create barriers that make it significantly hard for other firms to enter the market. Additionally, as few firms have a large part of the market share, they can influence the prices in a way that harms consumers and the general welfare of society.

Oligopoly characteristics

The most important characteristics of oligopoly are interdependence, product differentiation, high barriers to entry, uncertainty, and price setters.

• Firms are interdependent

As there are a few firms that have a relatively large portion of the market share, one firm’s action impacts other firms. This means that firms are interdependent. There are two main methods through which a firm can influence the actions of other firms: by setting its price and output.

• Product differentiation

When firms don’t compete in terms of prices, they compete by differentiating their products. Examples of this include the automotive market, where one producer might add specific features that would help them acquire more customers. Although the car price might be the same, they are differentiated in terms of the features they have.

• High barriers to entry

The market share acquired by the top companies in an industry becomes an obstacle for new companies to enter the market. The companies in the market use several strategies to keep other companies from entering the market. For instance, if firms collude, they choose the prices at a point where new companies can’t sustain them. Other factors such as patents, expensive technology, and heavy advertising also challenge new entrants to compete.

• Uncertainty

While companies in an oligopoly have perfect knowledge of their own business operations, they do not have complete information about other firms. Although firms are interdependent because they must consider other firms’ strategies, they are independent when choosing their own strategy. This brings uncertainty to the market.

Price setters

Oligopolies engage in the practice of price-fixing. Instead of relying on the market price (dictated by supply and demand ), firms set prices collectively and maximise their profits. Another strategy is to follow a recognised price leader; if the leader increases the price, the others will follow suit.

Oligopoly examples

Oligopolies occur in almost every country. The most recognised examples of oligopoly include the supermarket industry in the UK, the wireless communications industry in the US and the banking industry in France.

Let's take a look at these examples:

The supermarket industry in the UK is dominated by four major players, Tesco, Asda, Sainsbury's, and Morrisons. These four supermarkets control over 70% of the market share, making it difficult for smaller retailers to compete.

The wireless telecommunications industry in the US is dominated by four major carriers, Verizon, AT&T, T-Mobile, and Sprint (which merged with T-Mobile in 2020). These four carriers control over 98% of the market share, making it difficult for smaller carriers to compete.

The banking industry in France is dominated by a few large banks, such as BNP Paribas, Société Générale, and Crédit Agricole. These banks control over 50% of the market share and have a strong influence on the French economy.

Collusive vs non-collusive oligopoly

Collusive oligopoly occurs when firms form an agreement to jointly set prices and choose the production level at which they can maximise their profits.

Not all firms face the same production costs, so how does it work for firms with higher costs? Firms that might not be as productive in the market benefit from the agreement, as the higher price helps them stay in business. Other firms enjoy abnormal profit and keep problems that come with the competition out of their head. It’s a win-win for both.

Formal collusive agreements between firms are known as cartels. The only difference between collusion and monopoly is the number of firms, and everything else is the same. Collusion enables firms to increase prices and gain abnormal profits. One of the most famous cartels is the Organization of the Petroleum Exporting Countries (OPEC), which has significant influence over oil prices worldwide.

Cartels are the formal collusive agreements between firms.

Collusive oligopoly and cartel agreements are significantly harmful to consumers and the general welfare of society . Governments closely monitor these agreements and prevent them from taking place via anti-competitive laws.

However, when collusion is in the benefit and interest of the society, it is known as cooperation, which is legal and encouraged by governments. Cooperation does not involve setting prices to maximise profit . It instead involves actions such as improving health in a particular sector or increasing standards of labour.

Cooperation is a legal form of collusion for the benefit and interest of society.

Non-collusive oligopoly involves a competitive type of oligopoly where firms do not form agreements with one another. Rather, they choose to compete with one another in an oligopolistic market structure.

Firms will still depend on other firms’ actions as they share a large portion of the market, but firms are independent in their strategies. As there is no formal agreement, firms will always be uncertain how other firms in an oligopoly will react when they apply new strategies.

Simply put, in a non-collusive oligopoly, you have firms independently choosing their strategies whilst there is still interdependence amongst them.

The kinked demand curve

The dynamics in a non-collusive oligopoly can be illustrated by using the kinked demand curve . The kinked demand curve shows the possible reactions of other firms to one firm’s strategies. Additionally, the kinked demand curve helps show why firms don’t change prices in a non-collusive oligopoly.

Assume that the firm is in an oligopolistic market structure; it shares the market with a few other firms. As a result, it should be cautious of its next move. The firm is considering changing its price to increase profit further.

Figure 1 illustrates what happens to the firm’s output when it decides to increase its price. The firm is faced with elastic demand at P1, and an increase in price to P2 leads to a much higher drop in the output demanded compared to if the firm was faced with inelastic demand.

The firm then considers decreasing the price, but it knows that other firms will also decrease their prices. What do you think would happen if the firm decreased the price from P1 to P3?

As other firms will also reduce their prices, the quantity demanded will respond by very little compared to the price increase. How?

Other firms reacted by decreasing their prices too, which caused all the firms to share the total market share gained from the decrease in price amongst themselves. Therefore, none of them profits as much. That’s why there’s no incentive for firms to change their prices in a non-collusive oligopoly.

Price agreements, price wars, and p rice leadership in oligopoly

Price leadership, price agreements, and price wars often occur in oligopolies. Let’s study each of them independently.

Price leadership

Price leadership involves having a firm leading the market in terms of the pricing strategy and other firms following by applying the same prices. As cartel agreements are, in the majority of the cases, illegal, firms in an oligopolistic market look for other ways to maintain their abnormal profits, and price leadership is one of the ways.

Price agreements

This involves price agreements between firms and their customers or suppliers. This is especially helpful in case there is turmoil in the market as it allows firms to adjust their strategies better and address the challenges accordingly.

Price wars in an oligopoly are very common. Price wars happen when a firm tries to either take its competitors out of business or prevent new ones from entering the market. When a firm faces low costs, it has the ability to decrease the prices. However, other firms have different cost functions and can't sustain the price decrease. This results in them having to leave the market.

Advantages and disadvantages of oligopoly

The situation when there are a few, relatively large firms in an industry has its benefits and drawbacks. Let’s explore some of the advantages and disadvantages of oligopoly for both firms and customers.

Advantages of oligopoly

Both producers and consumers can benefit from the oligopolistic market structure. The most important advantages of oligopoly include:

• Firms can gain extreme profits due to little to no competition in an oligopoly market structure, allowing them to charge higher prices and expand their margins.
• Increased profits allow firms to invest more money into research and development, which benefits consumers through the development of new and innovative products.
• Product differentiation is a significant advantage of oligopolistic markets, as firms are constantly looking to improve and differentiate their products to attract more customers.
• Consumers benefit from having firms constantly trying to offer better products.

Disadvantages of oligopoly

The most significant disadvantages of oligopoly include:

• High prices, which can harm consumers, particularly those with low incomes
• Limited choices for consumers due to high market concentration amongst a few firms
• High barriers to entry prevent new firms from joining and offering their products, reducing competition and potentially harming social welfare
• Oligopolistic firms may collude to fix prices and restrict output, leading to further harm for consumers and decreased social welfare.

Oligopoly - Key takeaways

• Oligopoly occurs in industries where few but large firms dominate the market .
• The characteristics of oligopoly include interdependence, p roduct differentiation, high barriers to entry, u ncertainty, and price setters.
• The concentration ratio is a tool that measures the market share leading companies have in an industry.

Collusive oligopoly occurs when firms form an agreement to jointly set prices and choose the production level at which they can maximise their profits

Non-collusive oligopoly involves a competitive type of oligopoly where firms do not form agreements with one another. Rather, they choose to compete with one another.

The dynamics within a non-collusive oligopoly can be illustrated by using the kinked demand curve .

Price leadership involves having a firm leading the market in terms of the pricing strategy and other firms following by applying the same prices.

Price wars in an oligopoly happen when a firm tries to either take its competitors out of business or prevent new ones from entering the market.

Frequently Asked Questions about Oligopoly

--> what are price wars in oligopoly.

Price wars in an oligopoly are very common. Price wars happen when a firm tries to either take its competitors out of business or prevent new ones from entering the market. When a firm faces low costs, it has the ability to decrease the prices.

--> What is oligopoly?

Oligopoly occurs in industries where few but large leading firms dominate the market. Firms that are part of an oligopolistic market structure can't prevent other firms from gaining significant dominance over the market. However, as few firms have a significant share of the market, the behaviour of each firm can have an impact on the other. 

--> What are the four characteristics of oligopoly?

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What are the characteristics of an oligopolistic market?

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Define oligopoly.

Oligopoly occurs in industries where  few but large leading firms dominate the market.

Can firms in an oligopolistic market structure prevent other firms from gaining a significant share over the market?

Firms that are part of an oligopolistic market structure can't prevent other firms from gaining significant dominance over the market. However, as few firms have a significant share of the market, the behavior of each firm is capable of having an impact on the other.

What's the lower limit for a market to be considered oligopoly?

There must be a lower limit of two firms for a market structure to be considered oligopolistic.

Is there any upper limit as to how many firms can participate in oligopoly?

There's no upper limit to how many firms are in the market. It is essential that there are few and all of them combined have a significant share of the market, which is measured by the concentration ratio.

What is the concentration ratio?

The concentration ratio is a tool that measures the market share leading companies have in an industry

Mention examples of oligopoly.

Usually oil companies, supermarket chains, the pharmaceutical industry.

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Essay on Oligopoly and Collusion

Last updated 3 Feb 2019

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Here is what I feel is a superbly clear and well-structured essay answer to a question on the economic and social effects of collusion within an oligopoly.

Evaluate the view that collusion between firms in an oligopoly always works against consumer and society’s interests. Use game theory in your answer.

An oligopoly is where the industry or market is dominated by a few producers/firms with a high level of market concentration, where the component firms have a high level of interdependent decision making. Collusion can be tacit and/or explicit, and the aim of which is to achieve higher supernormal profits, with the firms as a whole achieving joint profit maximisation. Collusion between firms is harmful to consumers. This is because firms collude to raise prices, as mentioned earlier, resulting in the price level seen below. This reduces the consumer surplus available, reducing the welfare of individuals. This can often be highly regressive, if the impact of increased prices, such as with the Big Six Gas Suppliers, has a disproportionate impact on the less well off. Furthermore, because firms are working together, with internal quotas to divide up sales, there is less need to compete, resulting in less dynamic efficiency. This results in less innovation, and thus little improvement in the quality of products available to individuals. Indeed, the UK Competition and Markets Authority supports this claim, arguing that collusion can result in “reductions of output, efficiency, innovation and choice, all of which are harmful to consumers.” An example of this can be seen with Apple, who were sued by consumers for price-fixing with publishers to force consumers to over pay for e-books.

However, collusion between firms can often derive benefits for consumers. For instance, tacit collusion includes firms who monitor what other firms sell to ensure that they are matching the cheapest price in a geographical area, or who market that consumers are “never knowingly undersold” such as John Lewis. This is a case in which firms are technically engaging in tacit collusion, but which may also result in driving down of prices as firms seek to match improvements in cost efficiencies made by other firms. This is also true with products such as mobile phone contracts where it is easy to compare prices.

Collusion in an oligopoly can hugely benefit firms, which can have beneficial consequences for society. For instance, collusion between coffee growers allows small firms to push for fairer prices against more dominant monopsonistic corporations such as Starbucks. Furthermore, because these producer cooperatives like Fairtrade are often based overwhelmingly in less developed regions, this can also be useful in helping to alleviate extreme poverty. Furthermore, collusion allows for firms to lower the costs of competition, that can then be passed onto consumers. Because oligopolies exist in highly concentrated markets dominated by a few firms, there is often a huge degree of branding and differentiation that needs to take place in order for firms to stand out, e.g. with the UK retail banking industry with firms such as Barclays and HSBC. If all firms engage in marketing wars, there is no net societal benefit. However, if firms collude, they can reduce the need to fund these marketing wars, that can allow for cost savings to be passed onto consumers. Additionally, collusion allows for agreed upon industry standards, for instance with procedures in testing on humans in pharmaceutical research, which benefits both consumers and firms.

However, the extent to which this occurs depends on a few factors. Firstly, the vast majority of collusion that takes place isn’t that of poor farmers working together - oligopolies are more concentrated industries with very high barriers to entry, such as the Big Four Accountancy Firms, and pharmaceutical companies. Furthermore, the benefits that accrue from firms working together are dependent on those firms passing those cost savings onto consumers - however, if they are all explicitly colluding, they may decide to spend that money on share buy-back schemes and dividends, which may not benefit society at large. Indeed, in 2017, US firms spent more money on share buy-backs than they did on research and development. Lastly, the benefits from firms agreeing upon industry standards are likely to be very marginal given the government and regulatory bodies, such as the Financial Conduct Authority (FCA) tend to set industry standards centrally.

Conclusion:

In conclusion, the extent of the impact on consumers and firms depends fundamentally on how long the oligopoly is able to carry on collusion - we can analyse this through game theory. Assuming the following pay offs in a cartel such as OPEC, where states agree to collude to reduce production levels and benefit from a higher price:

If all firms cooperate, they will achieve £4bn revenue. However, if one firm decides to defect and to increase production while still gaining from higher prices, they will gain £5bn. The socially optimal equilibrium in this model (for firms) is to cooperate, because the total utility is greater than any other option. However, this is an unstable equilibrium: no matter what the other firm does, each agent is better off by defecting, resulting in a Nash equilibrium of Defect, Defect. Indeed, this model can be shown by how in October 2018, Iran accused Saudi Arabia and Russia of breaking OPEC’s agreement on cutting output. Thus, the effects of collusion are very much dependent on how long it is able to last.

Author: Cary Godsal (February 2019)

More resources available here on the topic of oligopoly

• Tacit Collusion
• Overt collusion
• Game Theory
• Nash Equilibrium

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1.5 Monopolistic Competition, Oligopoly, and Monopoly

Learning objective.

• Describe monopolistic competition, oligopoly, and monopoly.

Economists have identified four types of competition— perfect competition , monopolistic competition , oligopoly , and monopoly . Perfect competition was discussed in the last section; we’ll cover the remaining three types of competition here.

Monopolistic Competition

In monopolistic competition , we still have many sellers (as we had under perfect competition). Now, however, they don’t sell identical products. Instead, they sell differentiated products—products that differ somewhat, or are perceived to differ, even though they serve a similar purpose. Products can be differentiated in a number of ways, including quality, style, convenience, location, and brand name. Some people prefer Coke over Pepsi, even though the two products are quite similar. But what if there was a substantial price difference between the two? In that case, buyers could be persuaded to switch from one to the other. Thus, if Coke has a big promotional sale at a supermarket chain, some Pepsi drinkers might switch (at least temporarily).

How is product differentiation accomplished? Sometimes, it’s simply geographical; you probably buy gasoline at the station closest to your home regardless of the brand. At other times, perceived differences between products are promoted by advertising designed to convince consumers that one product is different from another—and better than it. Regardless of customer loyalty to a product, however, if its price goes too high, the seller will lose business to a competitor. Under monopolistic competition, therefore, companies have only limited control over price.

Oligopoly means few sellers. In an oligopolistic market, each seller supplies a large portion of all the products sold in the marketplace. In addition, because the cost of starting a business in an oligopolistic industry is usually high, the number of firms entering it is low.

Companies in oligopolistic industries include such large-scale enterprises as automobile companies and airlines. As large firms supplying a sizable portion of a market, these companies have some control over the prices they charge. But there’s a catch: because products are fairly similar, when one company lowers prices, others are often forced to follow suit to remain competitive. You see this practice all the time in the airline industry: When American Airlines announces a fare decrease, Continental, United Airlines, and others do likewise. When one automaker offers a special deal, its competitors usually come up with similar promotions.

In terms of the number of sellers and degree of competition, monopolies lie at the opposite end of the spectrum from perfect competition. In perfect competition, there are many small companies, none of which can control prices; they simply accept the market price determined by supply and demand. In a monopoly , however, there’s only one seller in the market. The market could be a geographical area, such as a city or a regional area, and doesn’t necessarily have to be an entire country.

There are few monopolies in the United States because the government limits them. Most fall into one of two categories: natural and legal . Natural monopolies include public utilities, such as electricity and gas suppliers. Such enterprises require huge investments, and it would be inefficient to duplicate the products that they provide. They inhibit competition, but they’re legal because they’re important to society. In exchange for the right to conduct business without competition, they’re regulated. For instance, they can’t charge whatever prices they want, but they must adhere to government-controlled prices. As a rule, they’re required to serve all customers, even if doing so isn’t cost efficient.

A legal monopoly arises when a company receives a patent giving it exclusive use of an invented product or process. Patents are issued for a limited time, generally twenty years (United States Patent and Trademark Office, 2006). During this period, other companies can’t use the invented product or process without permission from the patent holder. Patents allow companies a certain period to recover the heavy costs of researching and developing products and technologies. A classic example of a company that enjoyed a patent-based legal monopoly is Polaroid, which for years held exclusive ownership of instant-film technology (Bellis, 2006). Polaroid priced the product high enough to recoup, over time, the high cost of bringing it to market. Without competition, in other words, it enjoyed a monopolistic position in regard to pricing.

Key Takeaways

• There are four types of competition in a free market system: perfect competition, monopolistic competition, oligopoly, and monopoly.
• Under monopolistic competition , many sellers offer differentiated products—products that differ slightly but serve similar purposes. By making consumers aware of product differences, sellers exert some control over price.
• In an oligopoly , a few sellers supply a sizable portion of products in the market. They exert some control over price, but because their products are similar, when one company lowers prices, the others follow.
• In a monopoly , there is only one seller in the market. The market could be a geographical area, such as a city or a regional area, and does not necessarily have to be an entire country. The single seller is able to control prices.
• Most monopolies fall into one of two categories: natural and legal .
• Natural monopolies include public utilities, such as electricity and gas suppliers. They inhibit competition, but they’re legal because they’re important to society.
• A legal monopoly arises when a company receives a patent giving it exclusive use of an invented product or process for a limited time, generally twenty years.

Identify the four types of competition, explain the differences among them, and provide two examples of each. (Use examples different from those given in the text.)

Bellis, M., “Inventors-Edwin Land-Polaroid Photography-Instant Photography/Patents,” April 15, 2006, http://inventors.about.com/library/inventors/blpolaroid.htm (accessed January 21, 2012).

United States Patent and Trademark Office, General Information Concerning Patents , April 15, 2006, http://www.uspto.gov/web/offices/pac/doc/general/index.html#laws (accessed January 21, 2012).

Exploring Business Copyright © 2016 by University of Minnesota is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License , except where otherwise noted.

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What is Oligopoly: Types, Characteristics and Examples

• Pragya Soni
• Dec 18, 2021

Though, the British ruled period was a time of monopoly trade. But today, when globalization is at its peak, oligopoly is emerging as the leading market strategy. While the governments of a few countries are promoting it, others are banning it. 

Now the question arises, what is oligopoly in real life? How to identify it from monopoly? And if it is stable for the market or not. In this blog we will answer all your questions. We will read about the definition of an oligopoly market, its characteristics and consider a few real-life examples.

(Learn about Experimental economics )

What is the meaning of Oligopoly ?

The term oligopoly is basically related to economics and the market. It is a market controlling term. It may be defined as a market situation in which only a few producers affect the market. 

But that doesn’t mean they entirely control the market. The price change of each producer affects the actions of other producers. For instance, a reduction in the price of one producer may lead to an equal deduction by the other producers. 

This practice helps in retaining the same earlier share of the market but at lower profits. In oligopolistic industries the process is generally a blend of monopolistic and competitive tendencies. Oligopolies can be followed in several industries such as steel, aluminum and automobile industries.

In other words, oligopoly is defined as the market strategy that consists of several small numbers of firms. These firms or producers work explicitly to restrict output and thus control the market returns.

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Types of oligopoly

Oligopoly market industries or oligopolistic strategies are classified into following types:

Pure oligopoly

Pure oligopoly is also known as perfect oligopoly. This strategy has a homogeneous product. For example, the aluminum industry.

Imperfect oligopoly  

Imperfect oligopoly is also known as differentiated oligopoly. This industry has product differentiation at the end. For example, the talcum industry.

Open oligopoly

Open oligopoly refers to the market strategy where the new industries can enter in the market and can compete with the existing industries.

Closed oligopoly

Closed oligopoly is the opposite of open oligopoly. Here the entry of new or other industries into the market is strictly banned.

Collusive oligopoly

Collusive oligopoly is basically a cooperative market strategy. It occurs when few firms collaborate to an understanding in reference to the price and results of the products.

Competitive oligopoly  

Competitive oligopoly is the opposite of collusive oligopoly and basically a competitive strategy. This type of oligopoly occurs due to lack of understanding between the industries of the market. Due to which they create invariable competition for one another.

Partial oligopoly  

In this strategy there exists an industry as the price leader. The situation when a particular firm or industry is more powerful in the market as compared to other industries. A large firm basically dominates the entire market.

Total oligopoly  

Total oligopoly is also known as partial oligopoly. It is the opposite of partial oligopoly and no particular industry or firm dominates the market. There is no price leadership in the market.

Organized oligopoly

As the name suggests this is an organized structure of oligopoly. In this strategy, an association is formed to fix prices, quotas, and output.

Syndicated oligopoly

Syndicated oligopoly is the opposite of organized oligopoly. In this strategy the industries are allowed to sell their product through a centralized syndicate.

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What are the characteristics of oligopoly ?

Characteristics of oligopoly

The characteristics of an oligopoly market or oligopolistic strategy are mentioned below:

Interdependence

As in an oligopoly market, the decision of one firm influences the process and working of another firm. Thus, it induces interdependence in the network. It is the most important feature of an oligopolistic market. As this affects the prices and output of the market. A small change in a small firm has a direct impact on its rivals.

In order to match the impacts induced, the competitor firms might change their prices and profits. Thus, the oligopoly market is a totally interdependent network.

Advertising

Advertising is the key characteristic of the oligopolistic market. The firms are supposed to employ aggressive market techniques to defend the competition in the market. Due to interdependence, it is essential for the forms to invest a huge amount in the marketing and promotional activities. Thus, advertising has a great importance in an oligopoly strategy. 

Variable selling price

An oligopolistic market is a factor driven market and has interdependence on various factors. Thus, the selling price of the products in this market is quite unstable and varies at different instances.

Group behavior

The process of oligopoly is a group behavior. It is designed in such a way that a single firm can execute selfish behavior or profit-maximizing behavior. If it does, it automatically goes against the fundamentals of an oligopolistic market.

Entry barriers

Generally, it is difficult to enter an oligopolistic market, even in an open oligopoly. As it has to compete as a small start-up industry with large and economically stable firms. Here the most common entry barriers that are observed are as follows:

Exclusive resource ownership

Patents and copyrights

High start-up cost

Government restrictions

Few leading firms

There are only a few firms that control the entire sales and process of the market. In other words, the large number of firms is quite small in an oligopolistic market.

Identical or differentiated products

Unlike, monopoly market, the oligopoly market produces both kinds of goods, that is identical products and different products.

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How is oligopoly different from monopoly ?

In the modern era, there exist different market strategies such as monopoly and duopoly. Monopoly market refers to a market having only one producer. Similarly, duopoly has two producers in the market.

While oligopoly is the market strategy that involves a number of producers in the market. The upper limit of the number of producers in oligopoly is not fixed. But generally, the number is maintained in such a way that the decision and action of one industry or producer must affect and influence the others.

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What are the major examples of oligopoly market strategy ?

Examples of Oligopoly

In the modern era oligopoly is the most common market practice. The major examples of oligopoly markets are as follows:

Pharmaceutical sector

The pharmaceutical market is the most leading global market. It not only leads in drug innovation but also acts as a drug price maker. The pharmaceutical sector is a real example of oligopoly. 

As the market is controlled by top firms such as Merck, Pfizer and Abbott. The entry for new firms in this sector is quite limited and restricted.  As the patents are being registered here, it creates a notebook of experience for the future. Also, it can produce both similar and different products.

Media sector

Media sector is also a kind of oligopoly industry. Comparing the case of India, almost 90% of this sector is captured by leaders such as, The Tribune, ABP news etc. the decision of one producer totally influences the decision of other firms. 

And, if we minutely observe, the sector shows group behavior as well. And not a particular producer has the lead. You can yourself check that the prime time for every channel is different. This sector also invests huge amounts in advertising.

Computer technology industry

This sector is a best example of oligopoly. The entire computer technology market is globally dominated by two leaders named Apple and Windows. Due to their economic growth across the globe, no other firm is trying to enter in this sector. 

No matter what computer you choose, the embedded technology will be one of these two only. Thus, this sector serves a perfect example for a closed oligopolistic market.

Automobile industry

Similarly, the automobile industry is also an example of oligopoly. Let us take the case of India, no doubt, there are several automobile industries. But a dozen of them rule the market. 

These include Hyundai, Maruti, etc. Automobile sector is an example of organized oligopoly. As the standards and prices here are maintained by a generated authority.

Other examples of oligopoly strategy include following industries:

The steel industry

The petroleum industry

The photographic equipment industry

The cereal industry

The wine and beer sector

The aircraft manufacturing sector

The beverage industry

The gold jewelry makers

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The profits maximization of an oligopoly market is governed by the Kinked demand curve. Oligopoly industries are more stable over other market strategies as they work on collaboration. Thus, they are more beneficial in the era of economic competition. 

This strategy also avoids evil practices such as price-fixing. And identifies a price leader in the market, the other firms follow the price leader to maximize their benefits. The government must take essential efforts to expand the network of oligopolistic markets.

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Monopoly vs. Oligopoly: What's the Difference?

Monopoly vs. Oligopoly: An Overview

A monopoly and an oligopoly are market structures that exist when there is imperfect competition. A monopoly is when a single company produces goods with no close substitute, while an oligopoly is when a small number of relatively large companies produce similar, but slightly different goods. In both cases, significant barriers to entry prevent other enterprises from competing.

A market's geographical size can determine which structure exists. One company might control an industry in a particular area with no other alternatives, though a few similar companies operate elsewhere in the country. In this case, a company may be a monopoly in one region, but operate in an oligopoly market in a larger geographical area.

Key Takeaways

• A monopoly occurs when a single company that produces a product or service controls the market with no close substitute.
• In an oligopoly, two or more companies control the market, none of which can keep the others from having significant influence. 
• Anti-trust laws prevent companies from engaging in unreasonable restraint of trade and transacting mergers that lessen competition.  

A monopoly exists in areas where one company is the only or dominant force to sell a product or service in an industry . This gives the company enough power to keep competitors away from the marketplace. This could be due to high barriers to entry such as technology, steep capital requirements, government regulation, patents or high distribution costs.

Once a monopoly is established, lack of competition can lead the seller to charge high prices. Monopolies are price makers. This means they determine the cost at which their products are sold. These prices can be changed at any time. A monopoly also reduces available choices for buyers. The monopoly becomes a pure monopoly when there is absolutely no other substitute available.

Monopolies are allowed to exist when they benefit the consumer. In some cases, governments may step in and create the monopoly to provide specific services such as a railway, public transport or postal services. For example, the United States Postal Service enjoys a monopoly on first class mail and advertising mail, along with monopoly access to mailboxes.  

The United States Postal Service enjoys a monopoly on letter carrying and access to mailboxes that is protected by the Constitution.  

In an oligopoly, a group of companies (usually two or more) controls the market. However, no single company can keep the others from wielding significant influence over the industry, and they each may sell products that are slightly different.

Prices in this market are moderate because of the presence of competition. When one company sets a price, others will respond in fashion to remain competitive. For example, if one company cuts prices, other players typically follow suit. Prices are usually higher in an oligopoly than they would be in perfect competition .

Because there is no dominant force in the industry, companies may be tempted to collude with one another rather than compete, which keeps non-established players from entering the market. This cooperation makes them operate as though they were a single company.

In 2012, the U.S. Department of Justice alleged that Apple ( AAPL ) and five book publishers had engaged in collusion and price fixing for e-books. The department alleged that Apple and the publishers conspired to raise the price for e-book downloads from $9.99 to $14.99.   A U.S. District Court sided with the government, a decision which was upheld on appeal.  

In a free market, price fixing—even without judicial intervention—is unsustainable. If one company undermines its competition, others are forced to quickly follow. Companies that lower prices to the point where they are not profitable are unable to remain in business for long. Because of this, members of oligopolies tend to compete in terms of image and quality rather than price.

Legalities of Monopolies vs. Oligopolies

Oligopolies and monopolies can operate unencumbered in the United States unless they violate anti-trust laws. These laws cover unreasonable restraint of trade; plainly harmful acts such as price fixing, dividing markets and bid rigging; and mergers and acquisitions (M&A) that substantially lessen competition.  

Without competition, companies have the power to fix prices and create product scarcity, which can lead to inferior products and services and higher costs for buyers. Anti-trust laws are in place to ensure a level playing field.

In 2017, the U.S. Department of Justice filed a civil antitrust suit to block AT&T's merger with Time Warner, arguing the acquisition would substantially lessen competition and lead to higher prices for television programming.   However, a U.S. District Court judge disagreed with the government's argument and approved the merger, a decision that was upheld on appeal.  

The government has several tools to fight monopolistic behavior. This includes the Sherman Antitrust Act , which prohibits unreasonable restraint of trade, and the Clayton Antitrust Act , which prohibits mergers that lessen competition and requires large companies that plan to merge to seek approval in advance.   Anti-trust laws do not sanction companies that achieve monopoly status via offering a better product or service, or though uncontrollable developments such as a key competitor leaving the market.

Examples of Monopolies and Oligopolies

A company with a new or innovative product or service enjoys a monopoly until competitors emerge. Sometimes these new products are protected by law. For example, pharmaceutical companies in the U.S. are granted 20 years of exclusivity on new drugs. This is necessary due to the time and capital required to develop and bring new drugs to market. Without this protected status, firms would not be able to realize a return on their investment , and potentially beneficial research would be stifled.

Gas and electric utilities are also granted monopolies. However, these utilities are heavily regulated by state public utility commissions. Rates are often controlled, along with any rate increases the company may pass onto consumers.

Oligopolies exist throughout the business world . A handful of companies control the market for mass media and entertainment. Some of the big names include The Walt Disney Company ( DIS ), ViacomCBS ( VIAC ) and Comcast ( CMCSA ). In the music business, Universal Music Group and Warner Music Group have a tight grip on the market.

Federal Trade Commission. " The Antitrust Laws ."

U.S. Government Accountability Office. " U.S. Postal Service: Key Considerations for Potential Changes to USPS's Monopolies ," Pages 3, 4.

U.S. Department of Justice. " Justice Department Reaches Settlement with Three of the Largest Book Publishers and Continues to Litigate Against Apple Inc. and Two Other Publishers to Restore Price Competition and Reduce E-book Prices ."

U.S. Court of Appeals for the Second Circuit. " United States v. Apple Inc. ," Pages 4-19.

U.S. Department of Justice. " Justice Department Challenges AT&T/DirecTV’s Acquisition of Time Warner ."

United States Court of Appeals for the District of Columbia Circuit. " United States of America v. AT&T, Inc. Et Al ," Pages 4-34.

U.S. Food and Drug Administration. " Frequently Asked Questions on Patents and Exclusivity ."

• Antitrust Laws: What They Are, How They Work, Major Examples 1 of 24
• Understanding Antitrust Laws 2 of 24
• Federal Trade Commission (FTC): What It Is and What It Does 3 of 24
• Clayton Antitrust Act of 1914: History, Amendments, Significance 4 of 24
• Sherman Antitrust Act: Definition, History, and What It Does 5 of 24
• Robinson-Patman Act Definition and Criticisms 6 of 24
• How and Why Companies Become Monopolies 7 of 24
• Discriminating Monopoly: Definition, How It Works, and Example 8 of 24
• What Is Price Discrimination, and How Does It Work? 9 of 24
• Predatory Pricing: Definition, Example, and Why It's Used 10 of 24
• Bid Rigging: Examples and FAQs About the Illegal Practice 11 of 24
• Price Maker: Overview, Examples, Laws Governing and FAQ 12 of 24
• What Is a Cartel? Definition, Examples, and Legality 13 of 24
• Monopolistic Markets: Characteristics, History, and Effects 14 of 24
• Monopolistic Competition: Definition, How it Works, Pros and Cons 15 of 24
• What Are the Characteristics of a Monopolistic Market? 16 of 24
• Monopolistic Market vs. Perfect Competition: What's the Difference? 17 of 24
• What are Some Examples of Monopolistic Markets? 18 of 24
• A History of U.S. Monopolies 19 of 24
• What Are the Most Famous Monopolies? 20 of 24
• Monopoly vs. Oligopoly: What's the Difference? 21 of 24
• Oligopoly: Meaning and Characteristics in a Market 22 of 24
• Duopoly: Definition in Economics, Types, and Examples 23 of 24
• Oligopolies: Some Current Examples 24 of 24

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Home — Essay Samples — Economics — Oligopoly — A Research Paper On Oligopoly, Its Characteristics And Effects

A Research Paper on Oligopoly, Its Characteristics and Effects

• Categories: Economic System Oligopoly

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11 min read

Published: Nov 22, 2021

Words: 2046 | Pages: 4 | 11 min read

Table of contents

Introduction, theoretical reviews, effects on the market, advantages and disadvantages of oligopoly.

• High profits: Due to the small number of firms in an oligopoly, the firms can have high profits because of the low competition. The products or services under control of oligopolies are usually high in demand.
• Simple and few choices: Consumers have the ability to carefully choose the product they desire because its easier to compare them in this type of market. In other markets with big competitors, the price ranges and product differentiation makes it difficult for the consumer to choose.
• Competitive pricing: Usually the only differentiation between the products is the price, this causes the firms to lower their prices in order to compete with other similar firms. This is great for the consumers as prices will eventually lower.
• Advancement in products: Due to the number of competitors and product similarities in oligopoly, advancement in products is seen very often in this type of market because each firm is trying their best to get gain the loyalty and trust of the customers in the market.
• Difficulty of entry: It is very hard for a new firm to enter an oligopoly market because usually the market is already controlled by other well-known firms who already have the customers’ loyalty and the price control advantage.
• Fixed prices: Pricing strategies are used in an oligopoly market but the difference in the prices of products are rarely far apart. This is because the firms in the market agree upon a fixed price for the products or services. Fixed prices in markets usually mean firms have control over consumers and this causes consumers to pay more.
• Less choices: Consumers have limited options between the products and services they want.
• No fear of competition: Firms in an oligopoly market usually aren’t motivated to come up with new products or ideas because they control the market with other firms.

The Cournot Model

The prisoner’s dilemma, oligopoly markets in uk, cartel theory of oligopoly.

• Oligopoly. (n.d). Retrieved from: https://www.investopedia.com/terms/o/oligopoly.asp [Accessed 11th May 2018]
• N. Gregory Mankiw and Mark P. Taylor (2010) Economics. Special edition. Singapore. Stephen Wellings. Ian G. (2018) What is Oligopoly effects? Available at: https://www.chegg.com/tutors/what-is-Oligopoly-Effects/ [Accessed date 12th May 2018]
• Courtnot Competition (n.d). Available at: https://www.investopedia.com/terms/c/cournot-competition.asp [ Accessed date 12th May 2018]
• Cartel theory of oligopoly (2017). Available at: https://www.cliffsnotes.com/study-guides/economics/monopolistic-competition-and-oligopoly/cartel-theory-of-oligopoly [ Accessed date 13th May 2018]
• Eshna (2016) Market structures. Available at: https://uk.simplilearn.com/market-structures-rar188-article [Accessed date 13th May 2018]
• Vanshika Gho (2016) Kinked demand curve model of Oligopoly. Available at: http://www.economicsdiscussion.net/oligopoly/kinked-demand-curve-model-of-oligopoly-with-diagram/24162 [Accessed date 13th May 2018]
• N. Gregory Mankiw (1991) Principles of microeconomics. 1st edition. United States. Ted Buchholz.

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Oligopoly Industry Characteristics Coursework

Introduction, reference list.

This assignment is a discussion on the topic of marketing. In the discussion, attention is given to the oligopoly industry and its key features. This will be illustrated using the oil industry which comprises firms which do the business of oil and gas. The discussion also looks at the concept of price fixing by exploring the detergent industry especially in Europe and the economic rationale behind not fining Henkel, one of the companies which were found guilty of price fixing by the commission in charge of competition.

Oligopoly industry

Oligopoly is a market structure which is characterised by few but big firms. The firms usually know each other very well and they are characterised by sharing the whole market in terms of percentages. For example, if there are four big firms in a certain field, each usually occupies a certain percentage of the whole market in terms of capital base and the number of customers (Vives, 2001).

One characteristic of oligopoly is a cut throat competition. This means that the firms in an oligopoly industry usually compete for the customers but in very unique ways. Some of the ways in which firms compete is through what is referred to as differentiation and positioning.

In marketing, differentiation is the process of distinguishing a product or service from the rest through describing its unique differences and or characteristics. It is done for competition purposes with a view of creating a market niche for that particular product or service. Differentiation seeks to create a good image about a particular product among the targeted consumers so as to ensure that they perceive it as unique and different from other similar products (Armstrong and Kotler, 2009).

Product differentiation makes the targeted consumers not compare a particular product with others; which gives that particular product a competitive advantage over the others. In doing differentiation, marketers or product owners may rely on advertisement, promotions, improved product quality, lowering or increasing the prices as well as the lack of understanding on the part of the consumers regarding the price and quality of the product being differentiated (Armstrong and Kotler, 2009).

A company may engage itself in differentiation of several products at the same time. This makes it have a definitive number of customers, who are sort of owned by it due to the uniqueness of its products or services. This is what is called positioning. Positing entails using various strategies like promotion, distribution of products or services and production of unique products with unique pricing to build an identity of a particular company or organization in the minds of particular consumers (Vashisht, 2005).

Positioning seeks to stabilize and retain the positions of the particular differentiated products for a particular company so as to retain the competitive advantage of the company in regard to those products. For a company to create and maintain a particular position in a market, it needs to do a thorough research and consistent monitoring of market trends so as to modify or readjust the differentiation and positioning strategies for its respective products (Ferrell and Hartline, 2010).

The firms also compete through increasing their efficiency, which entails the maximization of their resources and ensuring that they provide services which are very efficient, reliable and of high quality. Those firms which are more efficient are the ones which use the minimal resources to achieve the maximum results. They can for example engage in what is referred to as human resource development, which entails things like training of employees on various tasks, so that the employees can work on various departments at different times. This makes the firms save on hiring more employees especially on contract basis because their full time employees are competent to undertake various tasks at the same time.

A good example of oligopoly in work is the oil industry, which is controlled by the body known as OPEC. The firms under OPEC usually dominate the oil industry in virtually all parts of the world. The key competitors in the oil industry include Saudi Arabian Oil Company (259,900 million barrels per year), National Iranian Oil (138,400 million barrels per year) and Qatar General Petroleum (15,207 million barrels per year) ( Petro Strategies, 2011).

What this means is that they try as much as possible to beat each other by competing for the customers for oil and gas products. It is usually not possible for one firm, say for example Arabian Oil Company to hike its prices or lower the quality of its products. This is because doing so would make it lose its customers to their major competitors.

In some cases, oligopoly leads to formation of business cartels. This happens when the firms agree to increase the prices of their products beyond the reach of many consumers. They can also decide to reduce the supply of some products so that the demand may go up, which consequently makes the prices to shoot up. This is however illegal and when the firms are detected, they are usually fined heavily by the relevant government authorities (Levenstein, Suslow and Oswald, 2003).

Price fixing

This is a conspiracy between buyers or sellers to control the trade of certain products for their own benefits. This conspiracy usually leads to creation of a cartel, which is usually illegal. Price fixing involves an agreement between the sellers or buyers of a product to have uniform standards, terms and conditions for the supply and demand of the product (Levenstein, Suslow and Oswald, 2003).

Sellers can conspire to purchase a product at a uniform price thus fixing the price at the level which they want. This is because the sellers can easily conspire through various forms of sophisticated communication and fix the prices of certain products. When this happens, the loser is always the buyer. The sellers usually achieve this thorough having uniform costs of production which entail transportation, labour, discounts and bonuses. Their ability to control and coordinate the flow of the goods and services as well as to communicate with each other on what price they should offer on a certain good or service further makes it hard for government authorities to detect their illegal practices (Bonin and Goey, 2009).

Price fixing usually takes place in industries which are dominated by few large firms, a characteristic of oligopoly discussed above. One such industry is the detergent industry in Europe. This industry is usually dominated by three major players namely the Unilever, Procter & Gamble and Henkel. These three giant firms operate in eight countries in Europe namely the Netherlands, Germany, Italy, Spain, Portugal, France, Belgium and Greece (Charyulu, 2011).

P&G is a leading producer of washing powder while Unilever is leading in production of detergents with brands of Omo and Surf. Henkel on its part leads in the production of the Persil brand in almost all parts of Europe. Due to their dominance in Europe, it is very easy for them to avoid stiff competition and engage in a deal to fix the prices of the products, which are very essential for daily lives of many people in Europe (Jones, 2005).

In 2002, the companies came up with a strategy to protect the environment. During the discussion, the companies went astray and constituted a cartel which operated in the eight countries of Europe named above between 2002 and 2005. The cartel was established basically to coordinate prices of products and stabilize the markets for the three companies involved. This is however prohibited by the EU (article 101) and the EEA (article 53) which state that the companies are not responsible for coordinating prices or stabilizing of the markets (Jones, 2005).

After three years in operation, it was Henkel which blew the whistle to the commission charged with regulation of competition in Europe, which swiftly engaged in investigations. The investigation confirmed that the cartel really existed and the companies were fined. P&D was fined 211million euros while Unilever was fined 104million euros.

These fines included a 10% discount because the companies acknowledged that they participated in a cartel. The commission also gave them the discount in fines because by accepting that they were involved in the cartel, the investigations were made easy and no much financial resources were used in the investigations (Blythe, 2006).

Henkel on it parts however received a full immunity from the commission for being the whistle blower about the cartel. The economic rationale behind not fining Henkel was because its act of blowing the whistle saved many customers huge sums of money, which they were to pay as a result of hiked prices of detergent products. The whistle blowing also made it easier for the commission to launch the investigations because Henkel gave it the necessary and crucial links in unearthing the cartel (Blythe, 2006).

The reason why Henkel blew the whistle is however subject to speculation. This is because it was from the start part and parcel of the cartel. Analysts argue that Henkel may have been receiving a raw deal in the cartel and therefore decided to blow the whistle. The case of the three companies in the detergent industry best illustrates how oligopoly works and how the key players put their own interests ahead of the interests of the consumers and those of their competitors (Blythe, 2006).

If Henkel could have gotten a good deal in the cartel, it would not have reported it because doing so would have compromised its ability to maximize its profits. The companies in the case were making what economists refer to as abnormal profits, leaving the consumers at the receiving end due to the absence of other companies which supply detergent products (Blythe, 2006).

This assignment was about the oligopoly industry. In the discussion, it has emerged that the industry is characterised by few but big firms which operate in a very competitive business environment. The firms usually rely on differentiation and positioning as the key strategies in boosting their competitive advantage over each other. The discussion has also looked at the concept of price fixing, using the oil industry and case of price fixing by three big firms in the detergent industry in Europe namely Unilever, P&D And Henkel.

Armstrong,G., and Kotler, P.(2009). Marketing. An Introduction . (9th, Ed.). Prentice Hall: Pearson Education Company.

Blythe, J.(2006). Principles & practice of marketing . Farmington: Cengage Learning.

Bonin, H and Goey, F.(2009). American firms in Europe: strategy, identity, perception and performance (1880-1980). Genève: Librairie Droz.

Charyulu, K.(2011). Rural Marketing . Pearson, GA: Pearson Education.

Ferrell, O.C., and Hartline,M.(2010). Marketing Strategy. Farmington: Cengage Learning.

Jones, G.(2005). Renewing Unilever: transformation and tradition . Oxford: Oxford University Press.

Levenstein, M., Suslow, V.Y and Oswald, L.J.(2003). International price-fixing cartels and developing countries: a discussion of effects and policy remedies . Farmington, MI: National Bureau of Economic Research.

Petro Strategies.(2011). Leading Oil and Gas Companies around the World. Web.

Vashisht, K.(2005). A Practical Approach to Marketing Management . New Delhi: Atlantic Publishers & Dist.

Vives, X. (2001). Oligopoly pricing: old ideas and new tools . Cambridge, MA: MIT Press.

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IvyPanda. (2019, July 10). Oligopoly Industry Characteristics. https://ivypanda.com/essays/oligopoly-industry/

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Bibliography

IvyPanda . "Oligopoly Industry Characteristics." July 10, 2019. https://ivypanda.com/essays/oligopoly-industry/.

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