10.3

• An oligopoly is a market structure where a few large firms dominate the industry. Unlike perfect competition, where firms are price takers, or monopoly, where a single firm controls the market, firms in oligopolies are interdependent. This means that each firm’s decisions (pricing, output) directly affect the other firms in the marke
• key characteristics of oligopolies:

  • few firms
  • interdependence
  • barriers to entry
  • potential for collusion
• Few firms: A small number of large firms control the majority of the market share.
• Interdependence: Firms must consider how their competitors will react to their decisions (e.g., changes in price or output).
• Barriers to entry: High barriers, such as economies of scale or legal restrictions, prevent new firms from easily entering the market.
• 1. Potential for collusion: Since firms are interdependent, they may collude (form agreements) to set prices or restrict output in order to maximize joint profits, acting like a monopolist.
• When firms in an oligopoly collude, they act as a collusive monopoly. This means they behave like a single monopolist, coordinating their output and price to maximize joint profits.
• Collusion can happen formally (through a cartel) or informally. For instance:

  • Formal collusion: Firms make explicit agreements to fix prices or limit output.
  • Informal collusion: Firms understand that competing aggressively would hurt everyone, so they implicitly agree to maintain higher prices without direct communication.
• • If firms in an oligopoly act independently, each firm will produce its own output as if they were in a competitive market.
  • In this case, the industry produces a total output of QC at a lower price of PC.
  • At this point, each firm is producing where MC = MR, but profits are lower because competition forces firms to produce more output at a lower price.
• • When firms collude (form a cartel), they restrict output to QM, which is lower than the competitive output QC.
  • The price at QM is higher: PM.
  • Collusion maximizes joint profits by acting as if the firms were a single monopoly. The higher price PM allows the firms to make larger profits at the expense of consumers who must pay more for the same product.
• • By restricting output, firms in an oligopoly can increase prices and profits. However, collusion is illegal in many countries due to its negative effects on consumers and market competition.
• One of the biggest challenges with collusion is that each firm has an incentive to cheat on the agreement.

  • Why would firms cheat?
  • In the collusive scenario, the industry restricts output to QM, but each firm could increase its output slightly to take advantage of the higher prices.
  • By increasing output beyond the agreed amount, a firm can make extra profits by selling more units at PM. However, if all firms cheat, the market becomes more competitive, driving prices down, and profits fall for everyone.
• A famous example of collusion is OPEC (Organization of Petroleum Exporting Countries). OPEC members collude by agreeing to limit the production of oil, thereby raising prices globally. While this allows OPEC countries to profit from higher oil prices, enforcement can be difficult since some members might produce more oil than agreed upon to gain more revenue.
• In oligopolistic markets, firms often engage in strategic decision-making, anticipating how their rivals will react
• Competitive oligopoly: Firms act independently, producing more output at a lower price.
• Collusive oligopoly: Firms coordinate to restrict output and raise prices to maximize joint profits.
• Competitive output (QC) is higher, and the price is lower (PC).
• Collusive output (QM) is lower, and the price is higher (PM), maximizing joint profits.