3.4.4 Oligopoly

• Characteristics of Oligopoly - 1

  High Barriers to Entry and Exit: Oligopolistic markets often have significant barriers that prevent new firms from entering the industry or existing firms from easily exiting

  
  

  These barriers can include: high capital requirements, economies of scale, patents, and government regulations
• Characteristics of Oligopoly - 2

  High Concentration Ratio: Oligopolies are characterized by a small number of large firms dominating the market

  
  

  The concentration ratio measures the market share held by the largest firms in the industry, and in oligopolistic markets, this ratio is typically high
• Characteristics of Oligopoly - 3

  Oligopolistic firms are highly aware of the actions and decisions of their competitors

  
  

  They must consider how their own choices, such as pricing and marketing strategies, will affect the behaviour and reactions of rival firms
• Characteristics of Oligopoly - 4

  Product Differentiation: Oligopolistic firms often engage in product differentiation to distinguish their offerings from competitors

  
  

  This can include branding, quality variations, and advertising to create brand loyalty
• Calculation of n-Firm Concentration Ratios

  It is calculated by summing the market shares of these firms

  
  

  sales of top 5 (3 or 4) firms/total sales of the industry x 100

  
  

  It is measures the combined market share of the largest n firms in the industry
• Significance of n-firm concentration ratios

  Higher concentration ratios indicate a more concentrated industry with fewer dominant firms

  
  

  Lower concentration ratios suggest a more competitive industry with a greater number of smaller firms

  
  

  It can provide insights into the degree of market power held by the largest firms + potential antitrust concerns
• Reasons for Collusive behaviour

  Maintaining High Prices: Firms in an oligopoly may collude to set high prices and limit competition, increasing their profits collectively

  
  

  Stability: Collusion can provide market stability, reducing uncertainty for firms and consumers

  
  

  Avoiding Price Wars: Collusion helps firms avoid destructive price wars
• Reasons for Non-Collusive behaviour

  Competition: Firms may choose to compete aggressively to gain market share and increase profits individually

  
  

  Legal Constraints: Antitrust laws and regulations prohibit collusion, encouraging firms to compete independently

  
  

  Differences in Objectives: Firms may have differing goals and incentives that make collusion difficult
• Overt Collusion

  Occurs when firms openly agree to cooperate and set prices or output levels.

  
  

  This can lead to the formation of cartels, which are explicit agreements among firms to coordinate their actions
• Tacit Collusion

  Involves firms behaving in a manner that resembles collusion without any explicit agreement.

  
  

  Firms may follow observed pricing patterns set by competitors or engage in price leadership, where one dominant firm sets the price and others follow suit
• Prisoner's Dilemma in a Two-Firm Model

  -Its a classic game theory scenario where two firms, make decisions that result in suboptimal outcomes

  
  

  -In an oligopolistic context, if both firms choose to compete aggressively, they may trigger a price war and both suffer lower profits
• Prisoner's Dilemma in a Two-Firm Model - 2

  -If both firms collude and set high prices, they both earn higher profits

  
  

  -The dilemma arises because each firm has an incentive to betray the collusion agreement to gain a larger share of the profits, but if both firms do this, they both end up worse off.
• Types of price competition: Price wars

  Fierce competition where firms continuously lower prices to gain market share, often resulting in reduced profits for all
• Types of price competition: Predatory pricing

  It occurs when a firm sets very low prices with the intent of driving competitors out of the market, after which it can raise prices.
• Types of price competition: Limit pricing

  A strategy where a dominant firm sets prices low enough to discourage new entrants from the market.
• Types of Non-Price Competition - 1

  Product Differentiation: Firms emphasize the unique qualities and features of their products through branding, quality, design, or advertising.

  
  

  Advertising and Marketing: Firms engage in extensive advertising and marketing campaigns to create brand loyalty and awareness.
• Types of Non-Price Competition - 2

  Innovation: Competing through the development of new products, technologies, or processes.

  
  

  Customer Service: Offering exceptional customer service and support as a competitive advantage.

  
  

  Distribution Channels: Establishing efficient distribution networks to reach customers faster and more conveniently.
• Significance of n-firm concentration ratios (2)

  • C.R close to 100% would be a strong oligopoly
  • C.R of 20-40% would be an oligopoly but a weak one (more competitive)
  • C.R in perfect & monopolistic competition would be < 1%
• Types of non-price competition - 3

  • raffles and competitions with prizes
  • special features
  • sales promotion
  • packaging
  • advertising
  • personal selling
  • late-night shopping
  • free delivery
  • publicity
  • brand names
  • sponsorship deals
  • after sales service