OLIGOPOLY

Oligopoly is the prevalent form of market structure. It is an important form of imperfect competition. Oligopoly is said to prevail when there are a few sellers or firms in the market producing or selling either homogeneous or differentiated product. In other words, when there are two or more than two, but not many, producers or sellers of a product, oligopoly is said to exist. Oligopoly is often referred to as “competition among the few”. If there are only two sellers, we have a ‘duopoly’. If the product is homogeneous, we have a ‘pure oligopoly’. If the product is differentiated, we have a ‘differentiated oligopoly’. In some oligopolistic markets, some or all firms earn substantial profits over the long run because barriers to entry make it difficult or impossible for a new form of market structure. Examples of Oligopolistic industries include automobiles, steel, aluminum, petrochemicals, electrical equipment, and computers.

Managing an oligopolistic firm is complicated because pricing, output, advertising and investment decisions involve important strategic considerations. Because only a few firms are competing, each firm must carefully consider how its actions will affect its rivals, and how its rivals are likely to react.

Example: Suppose that because of sluggish car sales, Ford is considering a 10 percent price cut to stimulate demand. It must think carefully about how Maruthi and Tata will react. They might not react at all, or they might cut their price only slightly, in which case Ford could enjoy a substantial increase in sales, largely at the expense of its competitors. Or they might match Fords’ price cut in which case all three automakers will sell more cars but might make much lower profits because of lower prices. Another possibility is that Maruthi and Tata will cut their prices even more than Ford. They might cut prices by 15 percent. to punish Ford for rocking the boat, and this in turn might lead to a price war and to a drastic fall in profits for all three firms. Ford must carefully weigh all three possibilities. In fact, for almost any major economic decision a firm makes – setting price, determining production levels, under taking a major promotion campaign or investing in new production capacity – it must try to determine the most likely response of its competitors.

Characteristics of Oligopoly
In oligopoly, some special characteristics are found which are not present in other market forms. We discuss some of these characteristics below:-

1. Interdependence

An important feature of oligopoly is the interdependence in decision-making of the few firms which comprise the industry. This is because when the number of competitors is few, any change in price or output by a firm will have a direct effect on the fortune of its rivals, which will then retaliate in changing their own prices and output as the case may be. Thus it is clear that the oligopolistic firm must consider not only the market demand for the industry’s product but also the reactions of the other firms in the industry to any action it may take.

2. Importance of advertising and selling costs

A direct effect of interdependence of oligopolists is that the various firms have to employ various aggressive and defensive marketing weapons to gain a greater share in the market or to prevent a fall in the share. For this various firms have to incur a good deal of costs on advertising and on other measures of sales promotion. Under perfect competition, advertising by an individual firm is unnecessary in view of the fact that he can sell any amount of his product at the going price. A monopolist may perhaps advertise when he has to inform the public about his introduction of a new model of his product or he may advertise in order to attract the potential consumers who have not yet tried his product. Under monopolistic competition, advertising may play an important role because of the product differentiation that exists under it, but not as much important as under oligopoly. Under oligopoly, advertising can become a life-and-death matter where a firm which fails to keep up with advertising budget of its competitors may find its consumers drifting off to rival products.

3. Group behavior

Group behavior is another important feature of an oligopolistic market. In case of perfect competition, monopoly and monopolistic competition, it is assumed that firms behave in such a way as to maximize their profits. But, the firms under oligopoly are interdependent with regard to price and output determination, they behave as a group. Given the present state of our economic and social science, there is no generally accepted theory of group behavior. Do the members of a group agree to pull together in promotion of common interests? Does the group present any leader? If so, how does he get the others to follow him? These are some of the questions that need to be answered by the theory of group behavior.

4. Indeterminateness of demand curve facing an oligopolist
The demand curve shows what amounts of his product a firm will be able to sell at various prices. Now, under perfect competition, an individual firm’s demand curve is given and definite. Since a perfectly competitive firm is one among a large number of firms producing an identical product, it is incapable of influencing the price of the product by its own individual action. Therefore, a firm under perfect competition faces a perfectly elastic demand curve at the existing price. On the other hand, a monopolist produces a product which has only remote substitutes. Therefore, a monopolist can safely ignore the effect of its own price changes on his distant rivals and he faces a definite demand curve depending up on the consumer’s demand for his product. Under monopolistic competition, where there are large number of firms producing products which are close substitutes of each other, changes in price by an individual firm will have a negligible effect on each of its many rivals. Therefore, a firm under monopolistic competition can validly assume the prices of its rivals to remain unchanged when it makes changes in the price of its product. And the demand curve for a firm under monopolistic competition can be taken as definite and is given by the buyer’s preferences for its product.


But the situation under oligopoly is quite different because of the interdependence of the firms. Under oligopoly, a firm cannot assume that its rivals will keep their prices unchanged when it makes changes in its own price. As a result of this, the demand curve facing an oligopolistic firm loses its definiteness and determinateness since it goes on constantly shifting as the rivals change their prices in reaction to price changes by a firm.

Types of Oligopoly

Since the oligopolistic firms are interdependent and the uncertainty about the reaction patterns of the rivals, the easy and determinate solution to the oligopoly problems is not possible. Therefore, economists have developed a large number of models by taking different assumptions regarding the behavior of the oligopolistic group(that is, when they will co-operate together or fight with each other)regarding the objective they seek to achieve (that is, whether they are assumed to maximize individual or joint profits or they are assumed to maximize security of sales) and regarding the different reaction patterns of rival firms to price and output changes by one firm. Some of the famous models advanced by economists are as follows.

1. Classical Oligopoly models which have been put forward by Cournot, Bertrant andEdgeworth. (Non-collusive model)

2. Price leadership model

3. Collusive oligopoly model

4. Kinked demand curve oligopoly model which has been put forward by P M Sweezy.

5. Application of the Theory of Games to Oligopoly

6. Average cost Pricing Theory of Oligopoly

7. Sales maximizing model of Oligopoly

8. Managerial and Behavioral theories of firm

9. Limit Pricing theory