Oligopoly

An oligopoly is an industry with small number of firms, at least one of which produces a significant portion of industry output.

• In an oligopoly there are very few sellers of the good.
• The product may be differentiated among the sellers (e.g. Automobiles) or homogeneous (e.g. Gasoline).
• Entry is often limited either by legal restrictions (e.g. Banking in most of the world) or by a very large minimum efficient scale (e.g. Overnight mail service) or by strategic behavior.

How Oligopolists Compete

In an oligopoly

* firms know that there are only a few large competitors
* competitors take account of the effects of their actions on the overall market.
* To predict the outcome of such a market, economists must model the interaction
between firms and so often use game theory or game theoretic principles.

Examples

1. Soft drinks/Sodas : Pepsi and Cola
2. Tobacco industry
3. CPU chips – Duopoly (an industry with only two firms): Intel and AMD
4. Beer
5. Light bulbs
6. Breakfast cereals
7. Automobiles

Causes of oligopoly

A. Natural Causes

* Economies of Scale – already discussed.
* Economies of Scope – the total cost of producing given quantities of two goods in the same firm is less than the total cost of producing those quantities in two single-product firms.

B. Firm Created Causes –

* Mergers and Acquisitions
* Prevention of Entry of New Firms
* Advertising


Strategic Behavior : firms take account of the actions and reactions of their competitors.

1. Cooperative Solutions (Cartels) – A cartel is a formal (explicit) agreement among firms.

* Cartel members agree on such matters as price fixing, total industry output, market shares, allocation of customers, allocation of territories, establishment of common sales agencies, and the division of profits or combination of these.
* The aim of such collusion is to increase individual member's profits by reducing competition.
* The cartel behaves like a monopoly.

Collusion –An explicit or implicit agreement between existing firms to avoid or limit
competition with one another

2. Non-Cooperative Outcomes - In non cooperative outcomes, there is no form of negotiation and binding contracts.eg while setting up a price of its product, a firm will take into account the other competitive firm’s behavior

Cartel problems with many firms

* Enforcement problems: few firms have incentive to “cheat” (increase their output while other members stick to prescribed output amounts).
* Restricting entry – many successful cartels have natural barriers to entry (e.g. Oil).

Collusion problems

* There are many firms in the industry
* The product is not standardized
* Demand and cost conditions are changing rapidly
* There are no barriers to entry
* Firms have surplus capacity