IGCSE Economics: Oligopoly
What is it?
- An oligopoly exists when there are several dominate firms in one market.
- If there are only two sellers in one market than that the market structure of the said market is a duopoly which is a special case of an oligopolistic market.
- Examples include the petroleum industry, TV broadcasting industry (duopoly in HK), supermarket industry and the banking industry.
- Please note that, as a general rule of thumb, even if a market has hundreds of providers, if the top 3 –7 providers together possess 50% or more of the market’s total market share then that market is said to be oligopolistic.
Main Features
- A few sellers dominate market supply/or a few sellers supply a major part of the total market supply irrespective of the total number of smaller suppliers in the market.
- The same goods but which are heavily differentiated by use of advertising, branding and other such methods.
- These firms produce similar but heavily differentiated products; this differentiation makes the goods look different to the consumer. (Heterogeneous goods)
- These firms engage in many forms of non-price competition but rarely deign to involve themselves in price based competition as such competition can lead to price wars which only benefit the consumers and no one else.
- Brand image is often very important for such firms. (Coke and Pepsi test).
- Oligopolistic firms will advertise a lot more than monopolists in the attempt to build a strong brand image and to differentiate their goods from the products of their competitors.
- If one firm has a better brand image, even with an inferior product, the said firm may be able to sell more of its product than another firm with a worse brand image.
- Entry into such markets is restricted either because of governmental decrees or because of the huge startup capital or technology requirements needed in order to open shop in the said market. Furthermore, because of the furious level of competition between existing oligopolistic firms, these firms generally produce at a very low price, a feat which would be very difficult for smaller firms which do not wield the same level of economies of scale as the larger oligopolistic firms.
- Market information is restricted and often incomplete as no firm knows what another competitor will do. To combat this, such firms often collude to form cartels (trade agreements) and conduct themselves with all the advantages, and disadvantages, of monopolists. These agreements are generally illegal.
- The actions of one firm will affect what the other competing oligopolistic firms will do as such firms will react very quickly to the actions of a competitor. (Sellers are highly interdependent).
Barriers to Entry
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- Existing firms are well established and have strong brand images.
- Existing firms enjoy economies of scale and are much more efficient.
- Existing firms enjoy customer confidence.
- The government may have issued rules that govern entry, sometimes for a certain number of years, into a certain market. These rules would have been put in place to encourage entrepreneurs to enter into a market where one would require large startup capitals. (Mobile phone industry in China).
Pricing Strategies:
- Price wars.
Price Leadership:
- When the dominate firm in a market determines the price of a good other firms have no choice but to follow their example or lose market share unless they choose to lower their prices even further and risk a price war.
- Sometimes they will even collude to prevent price wars from happening.
- Often used to avoid price wars.
Price collusion.:
- Forming a cartel.
- Predatory pricing otherwise known as destruction pricing.
Advantages
- Economies of scale (low average cost achieved on account of a high level of output).
- Excess (abnormal or supernatural) profits.
- Promotes research and development because these firms can spread the potential costs involved in R&D over a much larger range of income sources thus lowering the risk of R&D.
Disadvantages
- Lower output levels and higher prices as these firms control such things.
- Less choice for consumers.
- The need for government regulation to prevent oligopoly firms from overusing their powers.
