Main Economic Features of an Oligopoly

According to Pass et al (2000), “Oligopoly, a type of market structure is characterised by a few firms and many buyers, where the bulk of market supply is in the control of relatively few large firms who in turn sell to many small buyers”. To describe the degree of oligopoly, concentration ratio is often utilized. Concentration ratio is the measure of the market share of the largest four firms in the industry expressed as a percentage. A low concentration ratio suggests a high level of competition and vice versa for.

As there are few players dominating the industry, each player or an oligopolist is said or likely to be aware of others course of actions. The decision taken by one player seems to affect the decision taken by others and strategic planning by the firms needs to take into account the likely response of other participants (Wikipedia, 2010). For example, a proper game of chess depends on how well you read your opponent’s moves, similarly in oligopoly; strategies are devised based on the moves of competing market firms.

The reason for existence oligopoly as stated by Maunder et al (1991) is for the achievement of economies of scale. Firms tend to reduce their average cost of production by increasing their scale of operation and since the small firms have higher average costs, they tend to go out of business or be absorbed by the larger ones. The features of oligopoly are:

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• Number of Firms: The very important feature of an oligopoly is the number of firms. Even though there are a large number of firms operating in a particular industry, only a handful of firms hold the major share between them.
• Interdependence: A very distinctive feature of an oligopoly is interdependence. When a very few large firms operate in a particular industry, their activities or strategy cannot be independent of each other. Unlike monopoly, where the monopolist need not worry about the reaction of its rivals as there are none, an oligopolist takes into consideration the possible reactions of all rival firms. For example, a company considering a price reduction of its products may wish to estimate the chances of price reduction by the rival company and hence starting a price war.
• Profit Maximization Condition:  The firms in an oligopoly generally agree to co-operate and act as one monopolist as it generates high profits (Begg and Ward 2007). This kind of formal collusive agreement is called a cartel. An oligopoly maximises profits where the marginal revenue equals the marginal cost. This is also known as profit maximization condition.
• Perfect Knowledge:  Oligopolists are said to have a perfect knowledge about their cost and demand functions but a lesser information about other firms (Wikipedia, 2010).
• Entry Barrier:  One of the main important features of oligopoly also is the entry barrier. There are high entry barriers that restrain a new firm from entering a market. For example, the barriers can be the economies of scale, access to expensive and complex technology, lower costs for an established firm, brand loyalty, patented production process and strategic action by incumbent firms etc.

As discussed earlier, the large few firms form a cartel and set a price. Once the members of the cartel agree on the price, they compete against each other using non price competition in order to gain the maximum revenue. There are other various ways in which the firms fix the price. One of them being tacit collusion, where the firms agree on a price set by an established leader. This is also known as dominant firm price leadership as the price setting firm is the dominant firm in the industry.

The other way is the barometric firm price leadership, where the price leader is the one whose prices reflect the market conditions in the most stable form (Sloman et al, 2010). To fix prices, the producers must be able to control the market supply. The other forms of price fixing in tacit collusion is average cost pricing, where producers add a certain percentage of profit on top of average costs and price benchmarking, where firms raise the price only up to a benchmark already set.

Price fixing is achieved by the competing firms coming together on a platform where they can agree on a common pricing and production strategy thus acting in a manner in which a monopoly operates. This kind of collusion is known as cartelisation. Cartels although banned in many countries, is difficult for the enforcement agencies to gather evidence and penalise the participants. The quantity for the cartel and the individual firm will not be the same as one firm individually will have the scope for further increase in productivity to achieve a situation where the marginal cost equals the marginal revenue.

In such cases firms may decide to go ahead with excess supply which can lead to a price war and inconsistent revenues to the industry. Even without overt collusion firms in an oligopoly are able to reach a point of profit maximisation when they behave in a manner reflected in “Nash Equilibrium” (Begg and Ward 2007).

References

1. Begg, D. , and Ward, D. (2007). Economics for Business, 2nd edition. Berkshire: McGraw Hill Publication. Christopher Pass, Bryan Lowes and Leslie Davies (2000). Economics, 3rd edition.
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3. Indiadth, (2010). http://www. indiadth. in/ [Accessed 22/11/2010] Maunder, P. , Myers, D. , Wall, N. , and Miller, R. L. 1991) Economics Explained, 2nd edition. Collins Educational. Sloman, J. , and Hinde, K. (2007). Economics for business, 4th edition. Essex: Pearson Education Limited. Sun Direct, (2010). http://www. sundirect. com/packages. php [Accessed 22/11/2010]
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