Oligopoly Flashcards
Definition of Oligopoly
A market containing few firms
Why is Oligopoly so hard to define
It can take various forms, and its characteristics can vary significantly across industries
1. Product Differentiation
2. Number of Firms
3. Collusion and Behaviour
4. Lack of Clear Boundaries
5. Interdependence
6. Market Share and Concentration
Why is Oligopoly so hard to define: Product Differentiation
Oligopolies can exist with both homogeneous products (e.g., oil, steel) and differentiated products (e.g., cars, smartphones). This diversity complicates the definition, as the market dynamics and competition vary significantly based on whether products are standardised or differentiated.
Why is Oligopoly so hard to define: Number of Firms
There is no precise number of firms that defines an oligopoly. It typically refers to a market with a “few” dominant firms, but this can range from two (a duopoly) to several firms. The threshold for what constitutes “few” is often subjective.
Why is Oligopoly so hard to define: Collusion and Behaviour
Oligopoly is often defined by **the behaviour of firms, including the potential **for collusion. However, collusion may be explicit (e.g., forming a cartel) or tacit (firms implicitly cooperating without formal agreements). Distinguishing between competitive and collusive behaviour is not always straightforward, especially when firms use price leadership or other subtle forms of coordination.
Why is Oligopoly so hard to define: Lack of Clear Boundaries
**Market boundaries **are often not clearly defined, making it difficult to determine if a market is an oligopoly. The definition can vary based on geographic location, product substitutability, and market conditions. For instance, an industry might be considered an oligopoly on a national level but could face significant competition from global markets.
Why is Oligopoly so hard to define: Interdependence
A key characteristic of oligopoly is that firms are interdependent, meaning that the actions of one firm directly affect others. This interdependence is difficult to measure or define explicitly, as it requires assessing how sensitive firms are to each other’s decisions regarding pricing, output, or strategic moves.
Why is Oligopoly so hard to define: Market Share and Concentration
Defining oligopoly requires looking at the concentration of market power among firms. However, determining the level of concentration that qualifies a market as an oligopoly can be challenging, as it varies by industry and market conditions. Metrics like the concentration ratio (CR) or Herfindahl-Hirschman Index (HHI) are used, but their thresholds can be arbitrary.
Concentration Ratio definition (oligopoly)
The sum of the market share of the biggest firms in the market.
How to calculate Concentration Ratio (CR)
- Identify the Total Market Size
- Identify the Largest Firms (typically market shares in % terms)
- Sum the Market Shares
Interpretation of Concentration Ratio
High Concentration Ratio (e.g., CR > 80%): This suggests the market is dominated by a few large firms, indicating an oligopoly. The higher the ratio, the less competitive the market is.
Low Concentration Ratio (e.g., CR < 40%): This implies a more competitive market with many firms sharing the market, closer to perfect competition.
Pros of using the Concentration Ratio as a metric to define an oligopoly
They help indicate market power: High concentration ratios imply greater market power for the leading firms, often allowing them to influence prices and output levels.
They provide insight into market structure: Markets with a high concentration ratio are typically oligopolistic, while those with low concentration ratios could be monopolistic, monopolistically competitive, or perfectly competitive.
Cons of using Concentration Ratio as a metric to define an oligopoly
Ignores Smaller Firms: Concentration ratios focus only on the largest firms and disregard the competitive role that smaller firms may play.
No Insight on Firm Behaviour: It doesn’t show whether firms are colluding or engaging in competitive practices.
Market Dynamics: The ratio doesn’t capture dynamic changes in market share over time.
Real-life industries that are commonly used to illustrate concentration ratios and the degree of market concentration (Oligopoly)
1. Telecommunications (U.S.):
In the U.S. telecommunications industry, the CR is often quite high. Companies like AT&T, Verizon, T-Mobile, and Comcast together hold a substantial share of the market.
2. Automotive Industry (Global):
Globally, a small number of companies dominate the car manufacturing industry. Companies such as Toyota, Volkswagen, General Motors, and Ford collectively have a large market share, resulting in a high CR, typically over 50% for major markets.
3. Technology (Operating Systems):
In the desktop operating system market, the concentration ratio is extremely high. The CR involving Microsoft Windows, Apple macOS, and Linux accounts for well over 95% of the market share, with Windows alone holding a dominant position (above 70%).
Market Conduct definition
The price and other market policies pursued by firms.
Competitive Oligopoly definition
When firms are interdependent and independent
Market Conduct: Price Stability
One of the defining features of oligopolistic conduct is price rigidity. Firms in an oligopoly tend to avoid changing prices frequently, as price cuts could lead to destructive price wars, while price increases might cause them to lose market share to competitors. This behavior results in stable prices over time.
Market Conduct: Competitive Oligopoly: Interdependent but Independent
Despite the interdependence, each firm in a competitive oligopoly still acts independently in trying to maximize its own profit. Firms do not formally collaborate or communicate, unlike in collusive oligopoly scenarios. Each firm has its own pricing, production, and investment strategies. Although they keep an eye on competitors, firms operate autonomously to gain a competitive advantage
Market Conduct: Competitive Oligopoly: Interdependent but Independent: Sources of Uncertainty
The independence of firms in a competitive oligopoly creates uncertainty. This uncertainty stems from the inability of each firm to predict how its rivals will react to changes in pricing, output, advertising, or other strategic decisions
Competitive Oligopoly: Sources of Uncertainty: Changes in pricing
If one firm lowers its price, it is uncertain whether rivals will follow with similar reductions, hold their prices steady, or react with increased advertising. This unpredictability makes it difficult for firms to create long-term strategies, as any move could provoke a variety of responses.
Competitive Oligopoly: Sources of Uncertainty in shifting market dynamics
Competitive oligopolies often exist in markets with multiple products, differentiated offerings, and extensive use of advertising. The sheer complexity of the competitive environment adds to the uncertainty. Firms have to continuously monitor not only their direct rivals but also changes in consumer preferences, regulatory environments, and technological advancements that could shift market dynamics.
Competitive Oligopoly: Sources of Uncertainty: cautious behavior
Due to the uncertainty of rival reactions, firms in a competitive oligopoly often adopt cautious behavior to avoid triggering a destructive price war or other unfavorable outcomes. They may prefer stable prices and rely on non-price competition like advertising and product differentiation instead of engaging in aggressive price cuts.
Competitive Oligopoly: Interdependence
Interdependence means that firms cannot make decisions in isolation—they must consider how their rivals will respond. For example, if one firm lowers its prices, others may follow to avoid losing market share. This mutual dependence leads to strategic decision-making, often modeled using game theory.
Competitive Oligopoly: Game theory
The Prisoner’s Dilemma scenario shows that while mutual cooperation might lead to better outcomes, firms often struggle to trust one another, leading to competitive behavior. The Nash Equilibrium in such scenarios can lead to sub optimal outcomes for all firms involved due to the uncertainty of each firm’s actions.