Oligopoly

February 18, 2014

There exist different structures within the market based on the number of buyers and sellers in that market and based on the relationship that exists between them. Oligopoly is one of the market structures that exist in the market. Note that we rarely have a perfect market structure. We either have one structure being dominant in the market or a mixture of different structures. Here we are only concerned with the oligopoly or the oligopolistic market structure. In an oligopoly market form, the market is dominated by a small number of seller and not necessarily large number of buyers. The few sellers can therefore collude to alter the market prices and reduce competition between them. The Few numbers of sellers makes it easier for each firm in that market to know and monitor the action of other firms. Decision making under oligopoly market structure is dependent on the decision of other firms. Either a firm can influence the decision of other firm or can be influenced by other firms.  When making strategic decisions under the oligopoly market, a firm should consider the likely response of other firms in that market.

To quantitatively describe an oligopoly market structure, we use the four firm’s concentration ratio. This ratio will measure the share of the four largest sellers in the industry in terms of percentage. An oligopoly will exist if the four largest sellers control more than 80% of the total market. Oligopoly structure can yield a number of outcomes. In some markets, the firms restrict free trade by either sharing the market or colluding with each other as the case in a monopoly.  If the collusion is formal then we call it a cartel. The best known example of a cartel is in the oil producing countries under OPEC. The countries have colluded with each other to control the international oil prices. Collusion will come in two forms either formal or informal. Under informal collusion there is no formal agreement to control the market. For example, the leading firm in term market share can set prices and these prices are accepted by other firm in the market. Another possible outcome under the oligopoly structure is fierce competition between firms in that market. This will be a major advantage to the buyers as the competition yield high levels of production and relatively low prices.

Firms in oligopoly often collude to stabilize volatile market and therefore reduce risk in the market for investment and product development. Often when there is competition, firms will put more funds in countering competition and therefore starving research and product development.

The following are the major characteristics that describe the oligopoly market structure. The oligopoly firms do not take prices from the industry and are price setters. Under oligopoly market there are high entry barriers in forms of patents, economies of scales, expensive technology and action of firms in the market. Barrier can also be created by the government to protect important service industries. Other characteristics are abnormal long run profits, product differentiation, interdependence, perfect knowledge, and non price based competition.

 

 

 

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