Oligopoly

Key Terms
Oligopoly: Where a few large firms have the majority of the market share.

Concentration Ratio: The proportion of the market share held by the dominant firms.

Interdependent: Where actions by one firm will have an effect on the sales and revenue of other large firms in the market.

Theory

What is Oligopoly


An oligopoly is a market structure in which a small number of firms dominate the market. When market share is distributed between only a few firms, the market is said to be highly concentrated.


Key Features of Oligopoly

  • A few firms selling similar products
  • Branded products
  • High entry barriers
  • Interdependence
  • Non-price competition


    • Examples of Oligopoly

    Supermarket industry: TESCO, ASDA, Morrison’s, Sainsbury’s and Waitrose (5:87)

    Gaming Console industry: Nintendo, Sony and Microsoft.


    Competitive Oligopoly

    In competitive oligopoly, firms pursue an independent strategy and compete with each other but the firms are interdependent.

    kinked demand curve

    D2 – Prince increase = Elastic demand = no firms follow = Loss

    D1 – Price Decrease = inelastic demand = all firms follow = collective Loss

    It’s best for prices to remain the same or ‘sticky’


    Criticism of kinked demand curve

    1) Model does not indicate how original price is arrived at.

    2) Price changes do often occur in competitive oligopoly both when production costs change substantially and when unexpected shifts in demand take place.


    Pricing strategies

    Oligopolies often compete with one another by using pricing stratergies of which there are a number of types:


    1) Predatory pricing (illegal)

    Setting a low price that competitor cannot meet thus forcing them out of the market.


    2) Cost-plus pricing (AKA Mark-up pricing and full-cost pricing)

    cost plus pricing diagram

    Where a firm calculates average cost and adds a ‘mark-up’ to achieve desired profit level. P = AFC + AVC + profit margin.


    3) Price leadership

    A firm that is leader in its industry determines price of goods / service.


    4) Limit Pricing

    Prices set lower than maximising level (but high enough to make more profit than in perfect competition) so that super-normal profit does not attract new firms.


    Collusive Oligopoly

    Collusive oligopoly exists when oligopolies agree (formally or informally) to limit competition between themselves.

    Types of Collusion


    1) Formal collusion

    A situation where oligopolies act in agreement about price and output.


    2) Informal collusion

    Where one firms acts as price leader signalling changes in price to firms. There are various forms of this:

  • Dominant firm is price leader
  • Barometric pricing: A firm whose price changes are accepted as they are skilful at interpreting market conditions
  • Parallel pricing: Where firms charge identical prices


    • 3) Tacit collusion

    Where firms have reached an ‘agreement’ as to each other’s behaviour as a result of repeated observations over time.
    Advantages of Collusive Oligopoly
    Many of the advantages and disavantages of collusive oligopoly are the same as monopoly. There are, however, a few specific advantages of collusive oligopoly.

    1) Joint product development

    2) Ensuring industry safety standards

    3) Reduced market uncertainty = Increased spending on R&D









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