4.4 Oligopoly

• Characteristics of an oligopoly

  • High barriers to entry and exit
  • High concentration ratio
  • Interdependence of firms
  • Product differentiation
• Oligopoly as a market structure

  Firms operate in a market which is oligopolistic
• Oligopoly as a behaviour

  Several firms display oligopolistic behaviour
• Oligopolistic behaviour


  • Interdependence
  • Stable prices
  • Collusion
  • Non-price competition
• Cartel


  A group of two or more firms which have agreed to control prices, limit output, or prevent the entrance of new firms into the market
• Example of a cartel

  • OPEC
• Price leadership


  One firm changes their prices, and other firms follow
• Price war


  Price competition involving firms constantly cutting their prices below that of competitors
• Non-price competition


  Aims to increase the loyalty to a brand, which makes demand for a good more price inelastic
• Non-price competition strategies


  • Improving customer service
  • Keeping shops open longer
  • Special offers
  • Advertising and marketing
• Brands


  Used to differentiate between products, increasing brand loyalty makes demand more price inelastic
• Barriers to entry


  Designed to prevent new firms entering the market profitably, increasing producer surplus
• Game theory


  Used to predict the outcome of a decision made by one firm, when it has incomplete information about the other firm
• Example of game theory


  • Prisoner's Dilemma
• Nash equilibrium


  The optimal strategy for all players, whilst taking into account what opponents have chosen
• Kinked demand curve


  Illustrates the feature of price stability in an oligopoly, showing asymmetric reaction to price changes
• Collusive behaviour


  Firms agree to work together, e.g. setting price or output, to minimise competitive pressure
• Non-collusive behaviour


  Firms are competing, establishing a competitive oligopoly
• Overt collusion


  Formal agreement between firms
• Tacit collusion


  No formal agreement, but collusion is implied
• Cooperation


  Allowed in the market, with beneficial intentions
• Collusion


  Not allowed in the market, with poor intentions
• Concentration ratio


  The combined market share of the top few firms in a market
• Example of concentration ratio calculation

  • 4 firm concentration ratio = 72.8%
  • 2 firm concentration ratio = 45.5%
• Advantages of oligopoly


  • Significant supernormal profits, leading to more R&D and innovation
  • Higher profits as a source of government revenue
  • Improved industry standards through collaboration
• Disadvantages of oligopoly


  • Higher prices and profits, leading to inefficiency and misallocation of resources
  • Loss of consumer welfare from collusion
  • Collusion reinforcing monopoly power and reducing competition
  • Increased average cost of production