Oligopoly

This section explains Oligopolies and includes the Characteristics of Oligopoly and Reasons for Collusive and Non-Collusive Behaviour.

Oligopoly is a market structure where a few large firms dominate the industry. It is characterised by strategic behaviour, where firms take into account the actions and reactions of their rivals when making decisions.

Characteristics of Oligopoly

• High barriers to entry and exit: These may include economies of scale, brand loyalty, capital costs, or legal barriers, making it difficult for new firms to enter.
• High concentration ratio: A small number of firms hold a large percentage of total market share, often measured by the n-firm concentration ratio.
• Interdependence of firms: Firms must consider the likely reactions of rivals when changing prices, output, or strategy.
• Product differentiation: Products may be differentiated through branding, quality, or features, though some oligopolies sell homogenous goods (e.g., oil or steel).

Calculation of n-Firm Concentration Ratios and Their Significance

• The n-firm concentration ratio shows the combined market share of the top n firms in the market.
• Example: A 4-firm ratio of 80% means the top 4 firms control 80% of the market.
• A high concentration ratio indicates reduced competition and potential for collusion or price-setting power.

Reasons for Collusive and Non-Collusive Behaviour

This video explains Collusive and Non-Collusive Oligopolies.

Collusive behaviour occurs when firms agree (formally or informally) to avoid competition and maximise joint profits.

• Motivated by the desire to reduce uncertainty and protect profit margins.

Non-collusive behaviour arises when firms compete, often due to fear of legal penalties, new entrants, or market instability.

• Encouraged in more volatile or transparent markets.

Overt and Tacit Collusion; Cartels and Price Leadership

• Overt collusion: Formal agreements (e.g., cartels) where firms openly agree on prices or output (often illegal).
• Tacit collusion: Unspoken understanding where firms avoid price wars without formal agreement.
• Cartels: Groups of firms that collude to control prices or output (e.g., OPEC).
• Price leadership: A dominant firm sets a price that other firms in the market follow, maintaining stability without explicit collusion.

Simple Game Theory: The Prisoner's Dilemma

• Illustrates the strategic nature of oligopoly.
• In a two-firm, two-outcome model:
  • Both firms are better off cooperating, but the incentive to undercut the other leads to a worse collective outcome.
• Demonstrates why collusion may break down, and why competition may persist even when collusion seems rational.

Types of Price Competition

• Price wars: Successive rounds of price cuts between firms, often damaging to profits.
• Predatory pricing: Setting prices below cost to drive out competitors, potentially anti-competitive and illegal.
• Limit pricing: Setting prices low enough to deter new entrants, but still above cost.

Types of Non-Price Competition

Firms in oligopolies often compete through non-price methods, including:

• Branding and advertising: Building customer loyalty and market share.
• Product differentiation: Varying design, features, quality, or packaging.
• Customer service: Providing after-sales support, warranties, or loyalty schemes.
• Innovation and R&D: Developing new products or production methods.

Summary

Oligopoly is a complex and dynamic market structure where interdependence, barriers to entry, and strategic behaviour shape firm decisions. Outcomes depend heavily on whether firms collude or compete, and understanding these interactions through tools like game theory is key to analysing real-world markets.