Oligopoly

An oligopoly is a market condition or form which occur when market or industry is dominated by a small number of sellers called as oligopolists. Oligopolies can result because of various forms of collusion which reduce competition and lead to higher prices for buyers.

  • Competition between few. May be a large number of firms in the industry but the industry is dominated by a small number of very large producers
  • Concentration Ratio – the proportion of total market sales (share) held by the top 3,4,5, etc firms:
    • A 4 firm concentration ratio of 75% means the top 4 firms account for 75% of all the sales in the industry
  • Features of an oligopolistic market structure:
    • Price may be relatively stable across the industry
    • Potential for collusion
    • Behaviour of firms affected by what they believe their rivals might do – interdependence of firms
    • Goods could be homogenous or highly differentiated
    • Branding and brand loyalty may be a potent source of competitive advantage
    • Non-price competition may be prevalent
    • Game theory can be used to explain some behaviour
    • AC curve may be saucer shaped – minimum efficient scale could occur over large range of output
    • High barriers to entry

 

  • Example:

Oligopoly can be seen in the music industry –

Oligopoly 1

  • The music industry has a 5-firm concentration ratio of 75%.
  • Independents make up 25% of the market but there could be many thousands of firms that make up this ‘independents’ group.
  • The music industry as an oligopolistic market structure may have many firms in the industry but it is dominated by a few large sellers.

 

  • Diagrammatic representation

Oligopoly 2

  • Assume the firm is charging a price of £5 and producing an output of 100.
  • If it chose to raise price above £5, its rivals would not follow suit and the firm effectively faces an elastic demand curve for its product (consumers would buy from the cheaper rivals). The % change in demand would be greater than the % change in price and TR would fall.
  • If the firm seeks to lower its price to gain a competitive advantage, its rivals will follow suit. Any gains it makes will quickly be lost and the % change in demand will be smaller than the % reduction in price – total revenue would again fall as the firm now faces a relatively inelastic demand curve.
  • The principle of the kinked demand curve rests on the principle that:
  1. If a firm raises its price, its rivals will not follow suit
  2. If a firm lowers its price, its rivals will all do the same
  • The firm therefore, effectively faces a ‘kinked demand curve’ forcing it to maintain a stable or rigid pricing structure. Oligopolistic firms may overcome this by engaging in non-price competition.

 

Read about: Monopolistic Competition, Perfect CompetitionGross Domestic Product