Did you know...
... that the word oligopoly has been derived from the Greek word oligos which means 'little or small' and polein meaning 'to sell'. Wherever the word oligos is applicable as a plural, it means few.
Oligopoly is a common market form where an industry is dominated by a limited number of firms. A fierce competition exists among the oligopolistic firms, as they have low prices and high production. Oligopolistic firms may employ restrictive trade practices to increase prices and control production. Firms may even collaborate to stabilize unstable markets. The four-firm concentration ratio is utilized to quantitatively evaluate oligopoly. This includes measuring the market share in percentage for the top four largest firms in a particular industry. An apt example of oligopoly will be of the US cellular phone market. In the fourth quarter of 2008, 89% of the industry was controlled by Verizon, AT&T, Sprint, and T-Mobile.
An oligopolistic market is dominated by few large suppliers. Here, the leading firms account for a large percentage of market share. Firms manufacture branded products and high competition among them results in tremendous spending on advertising and marketing. Leading firms are able to make abnormal profits in the long run, as new firms have numerous entry barriers. As all firms in an oligopolistic market are interdependent, they need to consider the impact and reactions on other firms while determining their own pricing and investment policies. Homogeneous products, mutual interdependence, few large producers and high entry barriers are the major characteristics prevalent in such markets.
The automobile industry is a very good example of an oligopolistic market. There are various competitors in this market but the dominant ones include General Motors, Honda, Chrysler, Toyota and Ford. Entry barriers prevent other entrants and it is observed that pricing is mostly determined by competition and mutual understanding between top manufacturers.
Characteristics of Oligopoly
► Industry Dominance by Few Large Firms
This is a very crucial characteristic of oligopoly which states that this market includes few large firms which are dominant, and each one of these firms is comparatively larger than the market size. It ensures that all large firms have a fair amount of market control, not seen in a monopoly market. In spite of there being other smaller firms in the market, the major ones account for more than half of the total industry output. For example, in a hypothetical health insurance market, out of the 20 firms doing business the top 4 firms are responsible for 65% of the total industry sales, while the figure shoots up to 80% if the top 10 firms are taken into consideration.
► Homogeneous or Differentiate Products
Certain industries in an oligopolistic market manufacture homogeneous products, similar to a perfect competition market, while others manufacture differentiated products like in a monopolistic market. It can thus be inferred that oligopolistic markets are found in two separate categories:
Homogeneous Product Oligopoly: Industries in these markets produce intermediate goods which are used by other industries later for manufacturing their products. Examples include - steel, petroleum and aluminum industries.
Differentiate Product Oligopoly: Goods manufactured in these kinds of industries are for personal consumption. Consumers need a variety of products, as they have different needs and wants. Examples include - computers, household products and automobiles.
One of the key characteristics of oligopoly is interdependence. Any change in the price and other economic factors by a firm will also bring about a change in the pricing policy of the rivals, as competition is limited. Apart from taking into account the demand for its products or cost of the products, oligopoly firms also consider the reactions of other rival firms to changes in their price and output policies. However, mutual interdependence often creates uncertainty for all the firms. Hence, the demand curve of an oligopolistic firm losses its determinateness.
► Entry Barriers
Entry barriers help existing firms to exercise market control. Government restrictions, copyright and patent issues, huge setup cost and undivided resource ownership are common barriers to entry. This particular feature also helps in differentiating an oligopolistic market from a monopolistic market, as new firms can enter a monopolistic market and reduce dominance of the large firms. For example, if a new firm tries to enter a hypothetical telecommunications market it will have to compete against the already existing brand names, set-up a manufacturing unit without any initial sales or income from the business, and will also need to come up with innovative production techniques to sustain itself in the long run. All these barriers make it difficult for the new entrant to enter an oligopolistic market irrespective of the product.
► Advertising and Marketing Cost
Under an oligopolistic market, firms undertake aggressive marketing and advertising initiatives in order to gain greater market share. This not only generates publicity for the firm's products and services but also helps to increase its sales. In a monopolistic setup or a pure competition scenario, such a large sales promotional expenditure may not be required. However, it is essential for an oligopolistic firm to invest heavily in advertising and marketing for surviving the competition.
► Rigidity of Price
Oligopoly market has a rigid price structure. Changes in the prices of the products or services hardly take place in an oligopolistic market. Any deduction in the price by one firm is counter attacked by other competitive firms who also tend to undercut their prices. This results in a price war. To avoid such a situation, usually, firms avoid a price-cut or make a price-related decision in consultation with other firms.
► Non-price Competition
Oligopoly market follows a tough non-price competition. The competition exists in the form of loyalty schemes, advertisements, product differentiation, research and development, marketing, packaging, manufacturing products which are enhanced versions of rival products, etc.
► Profit Maximization
Oligopolistic firms maximize their profits at the quantity where the rising marginal cost is equal or near to the marginal revenue. This is achieved when the price of the product is greater than the average variable cost. As the entry in oligopolistic markets is difficult, above normal profits are possible only in the long run. However, these profits cannot exceed beyond a certain level as new competitors will enter the market eventually, and undercut the firms' prices and decrease the overall profits of the industry.
► Collective Dominance
Mergers or collaborations are a common feature of oligopolistic competition. Merging of two or more competitors helps them to act as one dominant entity in the market. This also increases their market share. It has a two-fold benefit where they can collectively achieve greater economies of scale, as well as reduce the competition. The firm which forms as a result of a merger will dominate and control market supply and prices of other smaller firms.
As the firms are interdependent on each other they must take strategic business decisions. They make important decisions on problems like whether to compete with rivals or collaborate with them, whether to change prices, whether to implement new strategies to make profit, etc. These decisions are usually based on estimating the rival firm's reaction to a strategic move.
► Perfect Knowledge
Oligopoly firms may assume to possess perfect knowledge of various economic factors and the actions of the competitors as only a few, large players exist. There are chances that they are fully aware of their own cost and other business-related details, however they may not be sure about the inter-firm information.
✦ The market is usually stable because of perfect knowledge.
✦ Oligopoly allows the firms to fix prices and control market.
✦ As the entry into the market is restricted, few people dominate the market.
✦ Oligopolistic firms benefit from long-term profits.
✦ Large players dominate the market and make huge profits.
✦ Other firms in the oligopolistic market will also make profit eventually due to the increase in demand.
✦ Profits can be invested in undertaking research and development of innovative products.
✦ Due to mergers, firms who manufacture similar products can lower the cost of manufacturing by collaborating with each other.
✦ Customers have a choice for making price comparisons before selection, unlike monopoly.
✦ Stability in prices of the products help the customer to undertake planned and calculated expenditure which in turn also helps to stabilize the trade cycle.
✦ Prices in oligopoly tend to be lower than those in monopoly.
✦ Oligopoly firms have access to patented processes and reap cost benefits of mass production.
There are various models like Dominant Firm Model, Bertrand model, Cournot-Nash Model and Sweezy's Kinked Demand Curve Model which are used to define the operation of firms in an oligopolistic market. As you may have observed, the characteristics of oligopoly are starkly different from the characteristics of monopoly. As the market is shared between a few firms, it is highly concentrated and, apart from the large firms, many small firms also work in this market. As a consumer, we gain more from the low pricing and new product development in a competitive oligopoly market than a monopoly market structure.