An oligopoly is a market dominated by a few large suppliers. The degree of market concentration is very high (i.e. a large % of the market is taken up by the leading firms). Firms within an oligopoly produce branded products (advertising and marketing is an important feature of competition within such markets) and there are also barriers to entry.
Another important characteristic of an oligopoly is interdependence between firms. This means that each firm must take into account the likely reactions of other firms in the market when making pricing and investment decisions. This creates uncertainty in such markets – which economists seek to model through the use of game theory.
Economics is much like a game in which the players anticipate one another’s moves.
Game theory may be applied in situations in which decision makers must take into account the reasoning of other decision makers. It has been used, for example, to determine the formation of political coalitions or business conglomerates, the optimum price at which to sell products or services, the best site for a manufacturing plant, and even the behaviour of certain species in the struggle for survival.
Adapted from Brittanica
The ongoing interdependence between businesses can lead to implicit and explicit collusion between the major firms in the market. Collusion occurs when businesses agree to act as if they were in a monopoly position.
KEY FEATURES OF OLIGOPOLY
* A few firms selling similar product
* Each firm produces branded products
* Likely to be significant entry barriers into the market in the long run which allows firms to make supernormal profits.
* Interdependence between competing firms. Businesses have to take into account likely reactions of rivals to any change in price and output
THEORIES ABOUT OLIGOPOLY PRICING
There are four major theories about oligopoly pricing:
(1) Oligopoly firms collaborate to charge the monopoly price and get monopoly profits
(2) Oligopoly firms compete on price so that price and profits will be the same as a competitive industry
(3) Oligopoly price and profits will be between the monopoly and competitive ends of the scale
(4) Oligopoly prices and profits are “indeterminate” because of the difficulties in modelling interdependent price and output decisions
THE IMPORTANCE OF PRICE AND NON-PRICE COMPETITION
Firms compete for market share and the demand from consumers in lots of ways. We make an important distinction between price competition and non-price competition. Price competition can involve discounting the price of a product (or a range of products) to increase demand.
Non-price competition focuses on other strategies for increasing market share. Consider the example of the highly competitive UK supermarket industry where non-price competition has become very important in the battle for sales
- Mass media advertising and marketing
- Store Loyalty cards
- Banking and other Financial Services (including travel insurance)
- In-store chemists / post offices / creches
- Home delivery systems
- Discounted petrol at hyper-markets
- Extension of opening hours (24 hour shopping in many stores)
- Innovative use of technology for shoppers including self-scanning machines
- Financial incentives to shop at off-peak times
- Internet shopping for customers
PRICE LEADERSHIP IN OLIGOPOLISTIC MARKETS
When one firm has a dominant position in the market the oligopoly may experience price leadership. The firms with lower market shares may simply follow the pricing changes prompted by the dominant firms. We see examples of this with the major mortgage lenders and petrol retailers.