Oligopoly

An oligopoly is a market structure where there are few relevant competitors and each of them has a certain capacity to influence the equilibrium price and quantity.

In the oligopoly, the competitors have market power, but at a lower level than in the case of the monopoly . This, since, instead of having only one offeror, there is a small group of companies.

This means that although each of the companies influences the market price and quantity (they do not take it as given), the freedom to choose the level of these variables is limited by the existence of other competing firms. A special case of oligopoly is the duopoly , where there are only two bidders.

Characteristics of the oligopoly

In what follows we will focus on the main characteristics of the oligopoly:

  • Small group of producers.
  • Producers can influence the market price and quantity.
  • They are strategically interdependent.
  • There are usually barriers to entry for new producers.
  • The product offered can be either homogeneous or differentiated.

Optimal choice in the oligopoly

Oligopolists face what is called strategic interdependence. That is, they know that the actions of some affect the results of others. So, for example, if my competitor decides to increase her production, the market price will probably fall and that will negatively affect my profits. Conversely, if my competitor reduces its production, this could have a positive effect on my profits.

Strategic interdependence makes the decisions made by each of the companies affect the final result of the market.

In general, we can find three basic oligopoly scenarios: leader-follower, simultaneous choice in quantities and simultaneous choice in prices.

  • Leader-follower: In this case we have that one company (generally the largest or oldest) first chooses the key variable (price or quantity) and then the other company or companies make their choice. Thus, for example, in the technology market we can see that IBM is a leading company and that its decisions set the tone for the production and price decisions of the smallest competing companies.

Optimal decision making in this competitive scenario is reflected in the model called Stackelberg where the leader must take into account the possible reaction of the follower to the level of quantity or price that he decides to choose. Subsequently, the follower takes as given or fixed the value selected by the leader to finally decide what will be his.

  • Simultaneous choice of quantities:Also known as the Cournot model, here companies decide at the same time the quantity to produce without a given value. In this case, companies maximize their benefits given their expectations or forecasts of the production decisions of the others.
  • Simultaneous choice of prices: Also known as the Bertrand model. In this case, companies also choose simultaneously and the end result approaches perfect competition when firms sell very similar (homogeneous) products.

 Collusion or anti-competitive agreement

Another possible scenario is that oligopolistic companies, realizing their strategic interdependence, decide to agree to not compete. This is what is called a collusion agreement , where companies agree on the price or quantity level so that they maximize their joint profits.

However, although collusion can be a very favorable scenario for companies, there are certain difficulties in achieving this. Indeed, the members of the agreement are tempted to cheat on their peers and thus increase their profits individually.

In this way, for a collusion agreement to be successful, companies need to find ways to control the behavior of their colleagues and sanction if there is a deviation.

In any case, collusion is illegal conduct that is prosecuted and sanctioned by the vast majority of countries that have competition laws. The body in charge of investigating and sanctioning this type of anti-competitive behavior is the Competition Agency .

Possible causes of an oligopoly

The fact that few companies compete in a market can be explained by the existence of barriers to entry . Among them, the most relevant is usually the presence of economies of scale that make the income of a company only viable when it can reach a significant proportion of the market.

However, there could also be an oligopoly due to legal or reputational barriers (brands that have been on the market for a long time).

Other types of imperfect competition

In the following table you can see all the market types in imperfect competition:

Market structure Number of bidders and degree of product differentiation Degree of price control Example
Monopoly A single bidder, there are no substitute products Full Monopoly on drinking water services (not regulated)
Oligopoly Few suppliers with homogeneous or differentiated products Any Vehicle Manufacturing (differentiated) or chemical products manufacturing (undifferentiated)
Monopolistic competition Many suppliers with differentiated products Any Fast food
Monopsony A single applicant Full Public work
Oligopsony Few claimants Any Large food distributors

 

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