Introduction
Oligopoly is one type of market structure in which there are many buyers and few sellers. In other words, each firm is relatively large in size as compared to the total industry as a whole. There are no buyer entry barriers, but there are seller entry barriers. Typically the firm size is average to large and they have homogeneous products. There is high competition and sellers achieve average market share. An oligopoly market consists of relatively large, well-known firms within an industry and the firms within each industry are well known brands. Each firm competing within the market has some form of interdependence on other firms within the market. Any potential new entrants would be very hard pressed to be a significant threat to the market share of any of these firms. Real-world examples of oligopolistic industries might include:
Satelite TV providers - Dish Network, Direct TV, etc
Auto manufacturers - GM, Ford, Chrysler, etc
Oil companies - BP, Chevron, etc
Cola companies - Pepsi, Coke, etc
Description
The outcomes of oligopolistic competition may vary widely depending on the interactions of the firms within the industry. Different assumptions could be made for the action and reaction of each company. The oligopolist firms are likely to be aware of the actions of the other firms, if nothing else because there are so few firms in the oligopoly groups. The decisions and actions of each firm may have a direct impact on the other firms, thus causing a reaction from rival firms. Oligopolist firms most likely will have strategic plans that take into account the expected series of actions and reactions from each firm.
However, it is not easy operating in an oligopolistic environment. From a manager's viewpoint, the oligopoly environment is the most difficult to manage because he must consider the likely impact of his decisions on the expected reaction of the other firms in the industry. A manager's optimal decision will heavily depend on what actions are taken by the other firms. If a manager lowers prices to induce an increase in sales, the manager may expect that competing firms would lower prices to stay more competitive. The opposite may or may not be true. If a manager tries to increase prices in order to increase revenue, the competing firms may not raise prices to stay more enticing to the customers.
There are numerous academically accepted models for different implications of the decisions made by a manager to achieve what they believe to be the firm's optimal profit in a given situation. A few of those models will be summarized below.
Summarizing Types of Oligopoly Models Cournot - A Cournot oligopoly is one that can have firms producing either differentiated or homogenous products. The main theory behind this model is the basic belief by a firm that the firm's rivals will maintain a constant output regardless of a change in the firm's output. In certain situations, an industry made up of just two firms (a.k.a. Cournot duopoly) may reach a point known as Cournot equilibrium. This is where neither firm has an incentive to change its output given the output of the other firm. Each firm assumes the competition will not change their output levels. Stackelberg - A Stackelberg oligopoly has the same primary characteristics of the other models, but is unique in the sense that a leader and follower relationship among firms will exist. In this case, a leader will determine their output before any other firms set their outputs. In turn, the other firms (the followers) determine their outputs in order to maximize their firm's profits based on the leader's given outputs. In this case, the leader will have a good sense of how the followers will react. Profits will be achieved for the leader and follower, but the leader typically makes much higher profits. An example of this might be when a gas station changes the price posted on the sign in front of the store. The other gas stations in town know what price that station (the leader) set for gas, so the other stations can either match the leader's price or choose to differ (up or down) to maximize their profits.
Bertrand - A Bertrand oligopoly again will have few firms and many customers with barriers to entry in existance for the sellers. Where a Bertrand oligopoly will differ from the other models is in the price of the products. In this model, all firms within the industry will produce the same products at a constant marginal cost. The firms will then compete in price and react based on competitors' prices in order to maximize profits. The assumption is that consumers will have perfect information on the products and there are no transaction costs. Any commodity would be a good example of the Bertrand oligopoly. Take aluminum for example. It is used in countless manufacturing applications. It is typically bought on contract in large quantities. Companies are always looking to purchase it at the lowest cost possible. If a new firm started offering aluminum at a lower cost than any other supplier, they would eventually take all the business away from the competitors or force the competitors to lower their price to stay competitive.
Other Types of Oligopoly
When firms work together to effectively create a monopoly, it is known as collusion. By working together, firms can maximize profits for the industry as a whole. A collusive duopoly is when two firms produce a combined output equal to the monopoly output level. By doing this, the total industry profit is maximized and split proportionally amongst the two firms. OPEC would be the most commonly known example of a collusion. The OPEC members determine how much oil they will produce as a whole so they can better control the price at which oil is sold on the open market. They can restrict output to drive prices up or increase output to help lower prices. Collusion is typically illegal for firms to engage in, but it may be difficult to prove. If collusion is taking place, member firms may have incentive to cheat on their agreement in order to increase their profits. The self-policing effect of cheating amongst firms typically prevents collusions from taking place.
Unlike a monopoly, a contestable market is one in which there is free entry for new entrants to join. In a contestable market, it is assumed that all producers have the same access to technology, there are no sunk costs, and consumers tend to repsond to price changes quickly. On the flip side, the existing firms cannot respond quickly to new entries by lowering prices. This combination of factors essentially eliminates market power of the firm over customers, in turn causing the market equilibrium price to equal the marginal cost of the product. In that case, there are zero economic profits. If new firms were able to enter the market with lower priced products, then all customers would migrate to the lower price and the original firm would lose all their customers. To prevent this from happening, the incumbant firm is forced to keep prices as low as possible to deter new firms from entering the market. The cell phone business is a good example of this in today's digital age. There are many companies that produce phones to sell in the very competitive market. Typically the various phones in a certain category have very similar festures and specs. The price becomes a driving force behind a customer's willingness to purchase one phone over another. Phone companies compete on price, thus driving down the prices to a rock-bottom level. In theory, the prices would drop until they're equal to the marginal cost of producing the phones. This in turn, deters any other new entrants with the same technology from enterring the cell phone market.
Summary
An oligopoly is a market scenerio positioned somewhere between a monopoly and full capitalism, or open market. An oligopoly doesn't quite have the same market influence as a monopoly, yet has significantly more influence than capitalistic firms. The market effect of an oligopoly will lead to higher prices on products or services than a capital market, but lower than a monopoly. Market prices remain more stable because of the interdependence between firms. Prices will have direct correlation with the market output. Market output in an oligopoly will be greater than a monopoly, but less than an open market. Technology, patents, and economies of scale are typical barriers to entry of new competitors. Various different models of oligopolies define the basic parameters of how firms within a market will interact. An oligopoly market may improve a firm's profit and efficiency, but may reduce the benefits of consumers by holding prices higher than a free market would. The fewer the number of firms competing in a market, the higher the costs will ultimately be for consumers.
References
www.mhhe.com/baye7e
Baye, Michael R., Managerial Economics and Business Strategy, 7th ed. New York, McGraw-Hill/Irwin, 2010.
Quiz Questions
1) The lowest market output in oligopoly situations is produced in which of the following?
a) Bertrand
b) Stackelberg
c) Cournot
d) Collusion
answer (d) - The highest market output is produced in a Bertrand oligopoly, followed by Stackelberg, then Cournot, and finally Collusion.
2) Profits are highest for which of the following oligopoly situations?
a) Stackelberg leader
b) Colluding firms
c) Both (a) and (b) above
d) Neither (a) nor (b)
answer (c) - Profits are highest for the Stackelberg leader and the colluding firms, followed by Cournot, then teh Stackelberg follower, and lastly the Bertrand oligopolists.
3) Which of the following is not true about a Stackelberg Oligopoly?
a) There are many firms serving few customers.
b) Firms produce either differentiated or homogeneous products.
c) A single firm (the leader) chooses an output before their rivals select their output
d) Barriers to entry exist.
answer (a) - In a Stackelberg oligopoly there are few firms serving many customers.
4) A market is not contestable if which of the following were to happen?
a) All producers have access to teh same technology.
b) Consumers respond quickly to price changes.
c) Existing firms cannot respond quickly to entry by lowering price.
d) Sunk costs exceed expected profits.
answer (d) - A market is contestable if there are no sunk costs.
5) Which of the following statements can be used to describe a Collusive Duopoly?
a) The duopolists produce a total output equal to the monopoly output.
b) In a symetric situation, each firm will produce half of the monopoly output.
c) The duopoly will maximize the total industry profits.
d) All of the above statements describe a Collusive Duopoly.
answer (d) - All the statements are true. A Collusive Duopoly acts like a single firm would in a monopoly.
*END OF GRADED SECTION*
Summaries:
Monopoly – A monopoly is a market which is solely served by a single firm and no alternative competitors. This firm has significant market power to charge higher prices than they could otherwise in a competitive market. The firm simply decides how much product should be produced. Without competition, customers are forced to decide between paying the higher prices or buying nothing at all. Monopolistic markets are created by means of economies of scale, economies of scope, cost complementary, or patents and other legal barriers. These are all ways to keep the competition out of the market. Monopolies are generally considered bad for society, so they are regulated by government authorities.
Perfect Competition – A market is considered perfectly competitive if there are large numbers of buyers and sellers, each firm produces an identical product, all parties have perfect information, there are no transaction costs, and there is free entry into and exit from the market. This ultimately means that no single buyer or seller can have a substantial influence on the overall market. Most agricultural products are good examples of perfect competition. Gasoline is another.
Profit – Ending profit is a simple calculation of total revenue minus total costs, thus leaving the remaining profit. But this simple form of economic profit does not take into account other factors such as opportunity costs. These are what could have been gained in an alternative course of action was taken. Many business decisions are made based on the expected profit of a certain course of action. If the economic profits are high enough, other firms will be enticed to join the market in hopes of realizing some of that profit for themselves.
Government Policies – The prohibition period is probably the most well known form of government policy that regulated sale of a product. The intent was to cease the consumption of alcohol. Instead, the market for alcohol remained strong and became an “underground” market. Since it was illegal, the price of alcohol increased due to the added risks of buying or selling it. The higher risk meant there was greater chance for big profit, but also a greater risk of getting caught by police. It also led to competitors resorting to crime (including death) to gain a strong hold on the illegal market. The intent of government policies is to reduce the negative socioeconomic benefits over time.
Production – Total production costs are the sum of implicit and explicit costs. The accounting costs of producing a product in addition to the opportunity costs all equate to the economic costs. Accounting costs are made up of fixed and variable costs. The fixed costs are given costs that cannot be avoided, regardless of how much product is produced. Variable costs are dependent upon the amount of product that is produced. Sunk costs are costs that cannot be recouped once they have been spent. The opportunity cost are the implicit costs.
Periodic Logs:
Entry 5: Various types of oligopoly models include Cournot, Stackelberg, Bertrand, and collusion. Bertrand oligopoly produces the highest market output, followed by Stackelbert, then Cournot, and finally collusion. The Stackelberg leader and colluding firms generate the highest profits, followed by Cournot, Stackelberg, and then Bertrand.
Entry 4: An oligopoly is typically a market dominated by between 2 and 10 firms. Strategic behavior and managerial decision making are the main keys to success. Four types of Oligopoly include Sweezy, Cournot, Stackelberg, and Bertrand.
Entry 3: An oligopolistic market tends to be dominated by a small number of firms. Classic examples are airlines, auto manufacturers, and aerospace industries. This type of market drives a mutual dependence relationship between all the firms. For example, if one firm changes their pricing, it forces the other firms to react and do the same. Knowing how to operate an oligopolistic firm is very difficult because the strategic plans need to depend on the expected response from competitors.
Entry 1: Oligopoly is one type of market structure in which there are many buyers and few sellers. There are no buyer entry barriers, but there are seller entry barriers. Typically the firm size is average to large and they have homogeneous products. There is high competition and sellers achieve average market share. Examples of such companies might be satelite TV providers (Dish Network, Direct TV, etc), auto manufacturers, oil companies, or cola companies (Pepsi, Coke, etc).
Oligopoly
- Kevin McNutt
Introduction
Oligopoly is one type of market structure in which there are many buyers and few sellers. In other words, each firm is relatively large in size as compared to the total industry as a whole. There are no buyer entry barriers, but there are seller entry barriers. Typically the firm size is average to large and they have homogeneous products. There is high competition and sellers achieve average market share. An oligopoly market consists of relatively large, well-known firms within an industry and the firms within each industry are well known brands. Each firm competing within the market has some form of interdependence on other firms within the market. Any potential new entrants would be very hard pressed to be a significant threat to the market share of any of these firms. Real-world examples of oligopolistic industries might include:
- Satelite TV providers - Dish Network, Direct TV, etc
- Auto manufacturers - GM, Ford, Chrysler, etc
- Oil companies - BP, Chevron, etc
- Cola companies - Pepsi, Coke, etc
DescriptionThe outcomes of oligopolistic competition may vary widely depending on the interactions of the firms within the industry. Different assumptions could be made for the action and reaction of each company. The oligopolist firms are likely to be aware of the actions of the other firms, if nothing else because there are so few firms in the oligopoly groups. The decisions and actions of each firm may have a direct impact on the other firms, thus causing a reaction from rival firms. Oligopolist firms most likely will have strategic plans that take into account the expected series of actions and reactions from each firm.
However, it is not easy operating in an oligopolistic environment. From a manager's viewpoint, the oligopoly environment is the most difficult to manage because he must consider the likely impact of his decisions on the expected reaction of the other firms in the industry. A manager's optimal decision will heavily depend on what actions are taken by the other firms. If a manager lowers prices to induce an increase in sales, the manager may expect that competing firms would lower prices to stay more competitive. The opposite may or may not be true. If a manager tries to increase prices in order to increase revenue, the competing firms may not raise prices to stay more enticing to the customers.
There are numerous academically accepted models for different implications of the decisions made by a manager to achieve what they believe to be the firm's optimal profit in a given situation. A few of those models will be summarized below.
Summarizing Types of Oligopoly Models
Cournot - A Cournot oligopoly is one that can have firms producing either differentiated or homogenous products. The main theory behind this model is the basic belief by a firm that the firm's rivals will maintain a constant output regardless of a change in the firm's output. In certain situations, an industry made up of just two firms (a.k.a. Cournot duopoly) may reach a point known as Cournot equilibrium. This is where neither firm has an incentive to change its output given the output of the other firm. Each firm assumes the competition will not change their output levels.
Stackelberg - A Stackelberg oligopoly has the same primary characteristics of the other models, but is unique in the sense that a leader and follower relationship among firms will exist. In this case, a leader will determine their output before any other firms set their outputs. In turn, the other firms (the followers) determine their outputs in order to maximize their firm's profits based on the leader's given outputs. In this case, the leader will have a good sense of how the followers will react. Profits will be achieved for the leader and follower, but the leader typically makes much higher profits. An example of this might be when a gas station changes the price posted on the sign in front of the store. The other gas stations in town know what price that station (the leader) set for gas, so the other stations can either match the leader's price or choose to differ (up or down) to maximize their profits.
Bertrand - A Bertrand oligopoly again will have few firms and many customers with barriers to entry in existance for the sellers. Where a Bertrand oligopoly will differ from the other models is in the price of the products. In this model, all firms within the industry will produce the same products at a constant marginal cost. The firms will then compete in price and react based on competitors' prices in order to maximize profits. The assumption is that consumers will have perfect information on the products and there are no transaction costs. Any commodity would be a good example of the Bertrand oligopoly. Take aluminum for example. It is used in countless manufacturing applications. It is typically bought on contract in large quantities. Companies are always looking to purchase it at the lowest cost possible. If a new firm started offering aluminum at a lower cost than any other supplier, they would eventually take all the business away from the competitors or force the competitors to lower their price to stay competitive.
Other Types of Oligopoly
When firms work together to effectively create a monopoly, it is known as collusion. By working together, firms can maximize profits for the industry as a whole. A collusive duopoly is when two firms produce a combined output equal to the monopoly output level. By doing this, the total industry profit is maximized and split proportionally amongst the two firms. OPEC would be the most commonly known example of a collusion. The OPEC members determine how much oil they will produce as a whole so they can better control the price at which oil is sold on the open market. They can restrict output to drive prices up or increase output to help lower prices. Collusion is typically illegal for firms to engage in, but it may be difficult to prove. If collusion is taking place, member firms may have incentive to cheat on their agreement in order to increase their profits. The self-policing effect of cheating amongst firms typically prevents collusions from taking place.
Unlike a monopoly, a contestable market is one in which there is free entry for new entrants to join. In a contestable market, it is assumed that all producers have the same access to technology, there are no sunk costs, and consumers tend to repsond to price changes quickly. On the flip side, the existing firms cannot respond quickly to new entries by lowering prices. This combination of factors essentially eliminates market power of the firm over customers, in turn causing the market equilibrium price to equal the marginal cost of the product. In that case, there are zero economic profits. If new firms were able to enter the market with lower priced products, then all customers would migrate to the lower price and the original firm would lose all their customers. To prevent this from happening, the incumbant firm is forced to keep prices as low as possible to deter new firms from entering the market. The cell phone business is a good example of this in today's digital age. There are many companies that produce phones to sell in the very competitive market. Typically the various phones in a certain category have very similar festures and specs. The price becomes a driving force behind a customer's willingness to purchase one phone over another. Phone companies compete on price, thus driving down the prices to a rock-bottom level. In theory, the prices would drop until they're equal to the marginal cost of producing the phones. This in turn, deters any other new entrants with the same technology from enterring the cell phone market.
Summary
An oligopoly is a market scenerio positioned somewhere between a monopoly and full capitalism, or open market. An oligopoly doesn't quite have the same market influence as a monopoly, yet has significantly more influence than capitalistic firms. The market effect of an oligopoly will lead to higher prices on products or services than a capital market, but lower than a monopoly. Market prices remain more stable because of the interdependence between firms. Prices will have direct correlation with the market output. Market output in an oligopoly will be greater than a monopoly, but less than an open market. Technology, patents, and economies of scale are typical barriers to entry of new competitors. Various different models of oligopolies define the basic parameters of how firms within a market will interact. An oligopoly market may improve a firm's profit and efficiency, but may reduce the benefits of consumers by holding prices higher than a free market would. The fewer the number of firms competing in a market, the higher the costs will ultimately be for consumers.
References
Quiz Questions
1) The lowest market output in oligopoly situations is produced in which of the following?
- a) Bertrand
- b) Stackelberg
- c) Cournot
- d) Collusion
answer (d) - The highest market output is produced in a Bertrand oligopoly, followed by Stackelberg, then Cournot, and finally Collusion.2) Profits are highest for which of the following oligopoly situations?
- a) Stackelberg leader
- b) Colluding firms
- c) Both (a) and (b) above
- d) Neither (a) nor (b)
answer (c) - Profits are highest for the Stackelberg leader and the colluding firms, followed by Cournot, then teh Stackelberg follower, and lastly the Bertrand oligopolists.3) Which of the following is not true about a Stackelberg Oligopoly?
- a) There are many firms serving few customers.
- b) Firms produce either differentiated or homogeneous products.
- c) A single firm (the leader) chooses an output before their rivals select their output
- d) Barriers to entry exist.
answer (a) - In a Stackelberg oligopoly there are few firms serving many customers.4) A market is not contestable if which of the following were to happen?
- a) All producers have access to teh same technology.
- b) Consumers respond quickly to price changes.
- c) Existing firms cannot respond quickly to entry by lowering price.
- d) Sunk costs exceed expected profits.
answer (d) - A market is contestable if there are no sunk costs.5) Which of the following statements can be used to describe a Collusive Duopoly?
- a) The duopolists produce a total output equal to the monopoly output.
- b) In a symetric situation, each firm will produce half of the monopoly output.
- c) The duopoly will maximize the total industry profits.
- d) All of the above statements describe a Collusive Duopoly.
answer (d) - All the statements are true. A Collusive Duopoly acts like a single firm would in a monopoly.*END OF GRADED SECTION*
Summaries:Monopoly – A monopoly is a market which is solely served by a single firm and no alternative competitors. This firm has significant market power to charge higher prices than they could otherwise in a competitive market. The firm simply decides how much product should be produced. Without competition, customers are forced to decide between paying the higher prices or buying nothing at all. Monopolistic markets are created by means of economies of scale, economies of scope, cost complementary, or patents and other legal barriers. These are all ways to keep the competition out of the market. Monopolies are generally considered bad for society, so they are regulated by government authorities.
Perfect Competition – A market is considered perfectly competitive if there are large numbers of buyers and sellers, each firm produces an identical product, all parties have perfect information, there are no transaction costs, and there is free entry into and exit from the market. This ultimately means that no single buyer or seller can have a substantial influence on the overall market. Most agricultural products are good examples of perfect competition. Gasoline is another.
Profit – Ending profit is a simple calculation of total revenue minus total costs, thus leaving the remaining profit. But this simple form of economic profit does not take into account other factors such as opportunity costs. These are what could have been gained in an alternative course of action was taken. Many business decisions are made based on the expected profit of a certain course of action. If the economic profits are high enough, other firms will be enticed to join the market in hopes of realizing some of that profit for themselves.
Government Policies – The prohibition period is probably the most well known form of government policy that regulated sale of a product. The intent was to cease the consumption of alcohol. Instead, the market for alcohol remained strong and became an “underground” market. Since it was illegal, the price of alcohol increased due to the added risks of buying or selling it. The higher risk meant there was greater chance for big profit, but also a greater risk of getting caught by police. It also led to competitors resorting to crime (including death) to gain a strong hold on the illegal market. The intent of government policies is to reduce the negative socioeconomic benefits over time.
Production – Total production costs are the sum of implicit and explicit costs. The accounting costs of producing a product in addition to the opportunity costs all equate to the economic costs. Accounting costs are made up of fixed and variable costs. The fixed costs are given costs that cannot be avoided, regardless of how much product is produced. Variable costs are dependent upon the amount of product that is produced. Sunk costs are costs that cannot be recouped once they have been spent. The opportunity cost are the implicit costs.
Periodic Logs:
Entry 5:
Various types of oligopoly models include Cournot, Stackelberg, Bertrand, and collusion. Bertrand oligopoly produces the highest market output, followed by Stackelbert, then Cournot, and finally collusion. The Stackelberg leader and colluding firms generate the highest profits, followed by Cournot, Stackelberg, and then Bertrand.
Entry 4:
An oligopoly is typically a market dominated by between 2 and 10 firms. Strategic behavior and managerial decision making are the main keys to success. Four types of Oligopoly include Sweezy, Cournot, Stackelberg, and Bertrand.
Entry 3:
An oligopolistic market tends to be dominated by a small number of firms. Classic examples are airlines, auto manufacturers, and aerospace industries. This type of market drives a mutual dependence relationship between all the firms. For example, if one firm changes their pricing, it forces the other firms to react and do the same. Knowing how to operate an oligopolistic firm is very difficult because the strategic plans need to depend on the expected response from competitors.
Entry 2:
Link to the Wikipedia page for oligopoly: http://en.wikipedia.org/wiki/Oligopoly
Entry 1:
Oligopoly is one type of market structure in which there are many buyers and few sellers. There are no buyer entry barriers, but there are seller entry barriers. Typically the firm size is average to large and they have homogeneous products. There is high competition and sellers achieve average market share. Examples of such companies might be satelite TV providers (Dish Network, Direct TV, etc), auto manufacturers, oil companies, or cola companies (Pepsi, Coke, etc).