oligopoly
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An oligopoly (from
Greek Greek may refer to: Greece Anything of, from, or related to Greece, a country in Southern Europe: *Greeks, an ethnic group. *Greek language, a branch of the Indo-European language family. **Proto-Greek language, the assumed last common ancestor ...
ὀλίγος, ''oligos'' "few" and πωλεῖν, ''polein'' "to sell") is a
market structure Market structure, in economics Economics () is the social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics foc ...
in which a market or
industry Industry may refer to: Economics * Industry (economics), a generally categorized branch of economic activity * Industry (manufacturing), a specific branch of economic activity, typically in factories with machinery * The wider industrial sect ...
is dominated by a small number of large sellers or producers. Oligopolies often result from the desire to maximize profits, which can lead to
collusion Collusion is a deceitful agreement or secret cooperation between two or more parties to limit open competition by deceiving, misleading or defrauding others of their legal right. Collusion is not always considered illegal. It can be used to att ...
between companies. This reduces competition, increases prices for consumers, and lowers wages for employees. Many industries have been cited as oligopolistic, including
civil aviation Civil aviation is one of two major categories of flying, representing all non-military and non-state aviation Aviation includes the activities surrounding mechanical flight and the aircraft industry. ''Aircraft'' includes airplane, fixed ...
,
electricity Electricity is the set of physics, physical Phenomenon, phenomena associated with the presence and motion of matter that has a property of electric charge. Electricity is related to magnetism, both being part of the phenomenon of electromagne ...

electricity
providers, the
telecommunications Telecommunication is the transmission of information by various types of technologies over wire, radio Radio is the technology of signaling and telecommunication, communicating using radio waves. Radio waves are electromagnetic waves of ...
sector, Rail freight markets,
food processing Food processing is the transformation of Agriculture, agricultural products into food, or of one form of food into other forms. Food processing includes many forms of processing foods, from grinding grain to make raw flour to home cooking to co ...
, funeral services,
sugar refining Sugar is the generic name for Sweetness, sweet-tasting, soluble carbohydrates, many of which are used in food. Simple sugars, also called monosaccharides, include glucose, fructose, and galactose. Compound sugars, also called disaccharides o ...
,
beer making
beer making
, pulp and paper making,
and automobile manufacturing.
and automobile manufacturing.
Most countries have laws outlawing anti-competitive behavior.
EU competition law European competition law is the competition law Competition law is the field of law that promotes or seeks to maintain market competition by regulating anti-competitive conduct by companies. Competition law is implemented through public an ...
prohibits
anti-competitive practices Anti-competitive practices are business or government practices that prevent or reduce Competition (economics), competition in a market. Antitrust laws differ among state and federal laws to ensure businesses do not engage in competitive practice ...
such as price-fixing and manipulating market supply and trade among competitors. In the US, the
United States Department of Justice Antitrust Division The United States Department of Justice Antitrust Division is a division of the United States Department of Justice, U.S. Department of Justice that enforces United States antitrust law, U.S. antitrust law. It has exclusive jurisdiction over U ...
and the
Federal Trade Commission The Federal Trade Commission (FTC) is an independent agency of the United States government whose principal mission is the enforcement of civil (non-criminal) antitrust law and the promotion of consumer protection. The FTC shares jurisdiction ...

Federal Trade Commission
are tasked with stopping collusion''.'' However, corporations can evade legal consequences through tacit collusion, as collusion can only be proven through actual and direct communication between companies. It is possible for oligopolies to develop without collusion and in the presence of fierce competition among market participants. This is a situation similar to
perfect competition In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In Economic model, theoret ...
, where oligopolists have their own
market structure Market structure, in economics Economics () is the social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics foc ...
. In this situation, each company in the oligopoly has a large share in the industry and plays a pivotal, unique role. With post-socialist economies, oligopolies may be particularly pronounced. For example in
Armenia Armenia (), , group=pron officially the Republic of Armenia,, is a landlocked country in the Armenian Highlands of Western Asia.The UNbr>classification of world regions places Armenia in Western Asia; the CIA World Factbook , , and '' ...
, where business elites enjoy oligopoly, 19% of the whole economy is monopolized ( BEEPS 2009 database), making it the most monopolized country in the
region In geography Geography (from Ancient Greek, Greek: , ''geographia''. Combination of Greek words ‘Geo’ (The Earth) and ‘Graphien’ (to describe), literally "earth description") is a field of science devoted to the study of the lan ...

region
.


Types of oligopoly

Commodities in the oligopolistic market are divided into two categories: # Homogeneous commodities: In the oligopolistic market of a primary industry, such as agriculture or mining, the commodities produced by such oligopolistic enterprises will have strong homogeneity. # Differentiated commodities: The differentiation of goods in the manufacturing and service industries will be very obvious. For example, different clothing companies may appeal to different demographics, and different mobile phone brands have different functions and appearances, etc. With few sellers, each oligopolist is likely to be aware of the actions of their competition. According to
game theory Game theory is the study of mathematical models of strategic interactions among rational agents. Myerson, Roger B. (1991). ''Game Theory: Analysis of Conflict,'' Harvard University Press, p.&nbs1 Chapter-preview links, ppvii–xi It has appl ...
, the decisions of one firm influence and are influenced by the decisions of other firms.
Strategic planning Strategic planning is an organization's business process, process of defining its strategy or direction, and making decision making, decisions on allocating its resources to attain strategic goals. It may also extend to control mechanisms for gu ...

Strategic planning
by oligopolists needs to take into account the likely responses of the other market participants. Entry barriers include high
investment Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance, the purpose of investing is ...
requirements, strong consumer loyalty for existing brands, and
economies of scale In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, and are typically measured by the amount of Productivity, output produced per unit of time. A decrease in unit cost, cost per u ...

economies of scale
. These barriers facilitate the formation and sustainability of collusion by stifling competition. Oligopolistic companies can form when several companies expand into large business groups by appreciating and increasing capital to buy smaller companies in the same markets, which increases the profit margins of the business.The fundamental reason oligopolies form is related to future retaliation (deviation). In a market with low entry barriers, price collusion between established sellers makes new sellers vulnerable to undercutting. Recognizing this vulnerability, the established sellers will reach a tacit understanding to raise entry barriers to prevent new companies from entering the market. Even if this requires cutting prices, all companies benefit because they reduce the
risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environme ...

risk
of loss created by new competition. In other words, firms will lose less for deviation and thus have more incentive to undercut collusion prices (obtain short-term deviated profit) when more join the market.The rate at which firms interact with one another is also expected to affect the incentives for undercutting other firms as the short-term rewards for undercutting competitors will be short lived where interaction is frequent and a degree of 'punishment' can expected swifty by other firms, but longer-lived where interaction is infrequent.Ivaldi, M., Jullien, B., Rey, P., Seabright, P., & Tirole, J. (2003). The economics of tacit collusion. Resultingly greater market transparency, in this case pertaining to the knowledge other firms have of prices and quantities of sales in rival firms, would decrease collusion. As oligopolistic companies would expect retaliation sooner where changes in their prices and quantity of sales are clear to their rivals. In developed economies, oligopolies dominate, as the perfectly competitive model is of negligible importance for consumers. Specifically, oligopolists will price fix, a practice that lessens buyer choice and raises prices, to dominate these markets. Most new prosecuted oligopoly cases in the US in 2013 were based on price-fixing. As a quantitative description of oligopoly, the four-firm concentration ratio is often utilized and is the most preferable ratio for analyzing
market concentration In economics, market concentration is a function (mathematics), function of the number of :wikt:firm, firms and their respective Market share, shares of the total production (alternatively, total capacity or total reserves) in a Market (economics ...
. This measure expresses, as a percentage, the market share of the four largest firms in any particular industry. For example, as of fourth quarter 2008, if we combine the total market share of Verizon Wireless, AT&T, Sprint, and T-Mobile, we see that these firms, together, control 97% of the U.S. cellular telephone market. These four cellular telephone firms have become the top-tier in US carriers and were protected by the US government that acted as an intervention for other firms entering the market. Oligopolistic
competition Competition is a rivalry where two or more parties strive for a common goal which cannot be shared: where one's gain is the other's loss (an example of which is a zero-sum game). Competition can arise between entities such as organisms, ind ...
can give rise to a wide range of outcomes. In some situations, particular companies may employ restrictive trade practices (
collusion Collusion is a deceitful agreement or secret cooperation between two or more parties to limit open competition by deceiving, misleading or defrauding others of their legal right. Collusion is not always considered illegal. It can be used to att ...
, market sharing etc.) in order to inflate prices and restrict production in much the same way that a
monopoly A monopoly (from Greek language, Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none), as described by Irving Fisher, is a market with the "absence of competition", creating a situati ...

monopoly
does. Whenever there is a formal agreement for such collusion between companies that usually compete with one another, this practice is known as a
cartel A cartel is a group of independent market participants who Collusion, collude with each other in order to improve their profits and dominate the market. Cartels are usually associations in the same sphere of business, and thus an alliance of ...

cartel
. A prime example of such a cartel is
OPEC The Organization of the Petroleum Exporting Countries (OPEC, ) is a cartel of countries. Founded on 14 September 1960 in Baghdad by the first five members (Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela), it has, since 1965, been headquart ...

OPEC
, where oligopolistic countries manipulate the worldwide oil supply and ultimately leaves a profound influence on the international price of oil. There are legal restrictions on such collusion in most countries and relevant regulations or enforcements against cartels (anti-competitive behaviours) enacted since the late of 1990s. For example,
EU competition law European competition law is the competition law Competition law is the field of law that promotes or seeks to maintain market competition by regulating anti-competitive conduct by companies. Competition law is implemented through public an ...
has prohibited some unreasonable anti-competitive practises such as directly or indirectly fix selling prices, manipulate market supply or control trade among competitors etc., either by means of formal contracts or oral agreements. In the US, the ''Antitrust Division of the Justice Department and Federal Trade Commission'' was created to fight collusion among cartels''.'' However, a formal agreement is not a requirement for collusion to take place, as tacit collusion can be achieved through mutual understanding among firms. For the collusion to be prosecuted as a crime there must be actual and direct communication between companies. For example, in some industries there may be an acknowledged market leader that informally sets prices to which other producers respond, (known as price leadership). Tacit collusion is becoming a more popular topic in the development of anti-trust law in most countries. In other situations, competition between sellers in an oligopoly can be fierce, with relatively low prices and high production. Hypothetically, this could lead to an efficient outcome approaching
perfect competition In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In Economic model, theoret ...
. The competition in an oligopoly can be greater when there are more competitors in an industry. Theoretically, it is harder to sustain cartels (anti-competitive behaviors) in an industry with a larger number of firms in that it will yield less collusive profit for each firm.Choi, J. P., & Gerlach, H. Forthcoming. Cartels and Collusion: Economic Theory and Experimental Economics. ''Oxford Handbook on International Antitrust Economics (Oxford University Press, Oxford, England)''. Consequently, existing firms may have more incentive to deviate. However, this conclusion is a bit more intuitive and empirical evidence has shown this conclusion or relationship is a bit more ambiguous and mixed. Thus the
welfare Welfare, or commonly social welfare, is a type of government support intended to ensure that members of a society can meet Basic needs, basic human needs such as food and shelter. Social security may either be synonymous with welfare, or refe ...
analysis of oligopolies is sensitive to the parameter values used to define the market's structure. In particular, the level of dead weight loss is hard to measure. The study of
product differentiation In economics and marketing, product differentiation (or simply differentiation) is the process of distinguishing a product (business), product or Service (economics), service from others to make it more Demand (economics), attractive to a particul ...
indicates that oligopolies might also create excessive levels of differentiation in order to stifle competition, as they could gain certain marker power by offering somewhat differentiated products. Oligopoly theory makes heavy use of
game theory Game theory is the study of mathematical models of strategic interactions among rational agents. Myerson, Roger B. (1991). ''Game Theory: Analysis of Conflict,'' Harvard University Press, p.&nbs1 Chapter-preview links, ppvii–xi It has appl ...
to model the behavior of oligopolies: * Stackelberg's
duopoly A duopoly (from Ancient Greek, Greek δύο, ''duo'' "two" and πωλεῖν, ''polein'' "to sell") is a type of oligopoly where two firms have dominant or exclusive control over a market. It is the most commonly studied form of oligopoly due to ...
. In this model, the firms move sequentially (see Stackelberg competition). * 's duopoly. In this model, the firms simultaneously choose quantities (see
Cournot competition Cournot competition is an economic model used to describe an industry structure in which companies compete on the amount of output they will produce, which they decide on independently of each other and at the same time. It is named after Antoine Au ...

Cournot competition
). * Bertrand's oligopoly. In this model, the firms simultaneously choose prices (see
Bertrand competition Bertrand competition is a model of competition used in economics, named after Joseph Louis François Bertrand (1822–1900). It describes interactions among firms (sellers) that set prices and their customers (buyers) that choose quantities at the ...
). When compared with Cournot and Bertrand's model, it can be seen that price competition is more aggressive and competitive, and also it is easier to sustain collusion under price competition.


Characteristics

Characteristics of oligopolies include: ; Profit maximization : An oligopoly will maximize its profits. ; Price setting : Oligopolies are price setters rather than prices takers.Perloff, J. ''Microeconomics Theory & Applications with Calculus''. page 445. Pearson 2008. ; High barriers to entry and exitHirschey, M. ''Managerial Economics''. Rev. Ed, page 451. Dryden 2000. : The most important barriers are government licenses,
economies of scale In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, and are typically measured by the amount of Productivity, output produced per unit of time. A decrease in unit cost, cost per u ...

economies of scale
, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy nascent firms. Additional sources of barriers to entry often result from government regulation favoring existing firms making it difficult for new firms to enter the market.Negbennebor, A: Microeconomics, The Freedom to Choose CAT 2001 ; Few firms : There are so few firms that the actions of one firm can influence the actions of the other firms. ; Abnormal long run profits : Oligopolies retain abnormal long run profits. High barriers of entry prevent sideline firms from entering the market to capture excess profits. ; Product differentiation : It can be homogeneous (steel) or differentiated (automobiles). ; Perfect knowledge : Assumptions about perfect knowledge vary, but the knowledge of various economic factors can be generally described as selective. Oligopolies have perfect knowledge of their own cost and demand functions, but their inter-firm information may be incomplete. Buyers have only imperfect knowledge as to price, cost, and product quality.


Interdependence

The distinctive feature of an oligopoly is
interdependence Systems theory is the Interdisciplinarity, interdisciplinary study of systems, i.e. cohesive groups of interrelated, interdependent components that can be natural or man-made, human-made. Every system has causal boundaries, is influenced by its c ...
. Oligopolies are typically composed of a few large firms. Each firm is so large that its actions affect market conditions. Therefore, the competing firms will be aware of a firm's market actions and will respond appropriately. This means that in contemplating a market action, a firm must take into consideration the possible reactions of all competing firms and the firms' countermoves.Colander, David C. Microeconomics 7th ed. Page 288 McGraw-Hill 2008. It is very much like a game of
chess Chess is a board game between two Player (game), players. It is sometimes called international chess or Western chess to distinguish it from chess variant, related games, such as xiangqi (Chinese chess) and shogi (Japanese chess). The current ...

chess
, in which a player must anticipate a whole sequence of moves and countermoves in order to determine how to achieve his or her objectives; this is known as
game theory Game theory is the study of mathematical models of strategic interactions among rational agents. Myerson, Roger B. (1991). ''Game Theory: Analysis of Conflict,'' Harvard University Press, p.&nbs1 Chapter-preview links, ppvii–xi It has appl ...
. For example, an oligopoly considering a price reduction may wish to estimate the likelihood that competing firms would also lower their prices for retaliation and possibly trigger a ruinous
price war A price is the (usually not negative) quantity of payment or Financial compensation, compensation given by one Party (law), party to another in return for Good (economics), goods or Service (economics), services. In some situations, the pr ...
. Or if the firm is considering a price increase, it may want to know whether other firms will also increase prices or hold existing prices constant. This anticipation leads to price rigidity, as firms will only be willing to adjust their prices and quantity of output in accordance with a "price leader" in the market. An example for this interdependence among oligopolists such that
Texaco Texaco, Inc. ("The Texas Company") is an American Petroleum, oil brand owned and operated by Chevron Corporation. Its flagship product is its Gasoline, fuel "Texaco with Techron". It also owned the Havoline motor oil brand. Texaco was an Indepe ...

Texaco
needs to take into consideration whether its own price cut will trigger Shell's incentive to match, and so that the benefit or privilege gained by low price would be eliminated. This high degree of interdependence and need to be aware of what other firms are doing or might do stands in contrast with the lack of interdependence in other market structures. Simply put, every oligopolistic company that appears in companies with strong commodity homogeneity is reluctant to raise or lower prices. For example, if company A increases its price but B does not, A will lose all the market in an instant; if A decreases its price, B will inevitably decrease its price, which will lead to a price war for both parties and ultimately lose both sides. Therefore, raising or lowering the price does not do itself any good, and the best strategy is to keep the price the same. The price rigidity caused by the mutual game between oligopolistic enterprises is called interdependence. In a perfectly competitive (PC) market there is zero interdependence because no firm is large enough to affect market price. All firms in a ''PC'' market are price takers, as the current market selling price can be followed predictably to maximize short-term profits. In a
monopoly A monopoly (from Greek language, Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none), as described by Irving Fisher, is a market with the "absence of competition", creating a situati ...

monopoly
, there are no competitors to be concerned about. In a monopolistically-competitive market, each firm's effects on market conditions are so negligible as to be safely ignored by competitors.


Non-price competition

Generally speaking, the oligopolistic enterprise with the largest scale and the lowest cost will become the price setter in this market, and the price set by it will maximize its own interests and ensure that other small-scale enterprises also benefit. Oligopolies tend to compete on terms other than price. Loyalty schemes, advertisement, and product differentiation are all examples of
non-price competition Non-price competition is a marketing strategies, marketing strategy "in which one firm tries to distinguish its product (business), product or Service (economics), service from Competition, competing products on the basis of attributes like design ...
, which is perceived less risky and brings less disastrous impacts to business. In other words, oligopolists are able to extract more rents (charge prices above normal competition level without losing large consumers) by offering differentiated products or initiating promotion efforts. However, collusion among oligopolists is harder or more difficult to sustain along such non-price dimensions such as differentiation, marketing, product design. For fighting collusion and cartels in an oligopoly market, competition authorities have taken measures or practices to effectively discover, prosecute and penalize them.Harrington, J. E. (2006). Behavioral screening and the detection of cartels. ''European competition law annual'', 51-68.Leniency program
and economic analysis (screening) are currently two popular mechanisms.


Leniency program

Competition authorities prominently have roles and responsibilities on prosecuting and penalizing existing cartels and desisting new ones. Thus, authorities have created an effective tool called the leniency program, which makes antitrust firms to be more proactive participants in confessing their collusion behaviors in that they will be granted immunity from fines and still have a right to plea bargaining if not receive a full reduction. Nowadays, leniency program has been implemented by several countries like US, Japan and Canada. However, it causes negative impacts to competition authorities themselves in the wake of abusing of leniency program that there are still many cartels in society and the expected sanctions for colluded firms will experience a sharp drop. As a result, the total effect of the leniency program is ambiguous and an optimal leniency program is required.


Economic analysis

There are two screening methods that are currently available for competition authorities: structural and behavioral. In terms of structural screening, it refers to identify industry traits or characteristics, such as homogeneous goods, stable demand, less existing participants, which are prone to cartel formation. While regarding behavioral one, is mainly implemented when a cartel formation or agreement has reached and subsequently authorities start to look into firms' data and figure out whether their price variance is low or has a significant price increase or decrease.


Oligopolies in countries with competition laws

Oligopolies become "mature" when competing entities realize they can maximize profits through joint efforts designed to maximize price control by minimizing the influence of competition. As a result of operating in countries with enforced
antitrust laws Competition law is the field of law that promotes or seeks to maintain market competition by regulating anti-competitive conduct by companies. Competition law is implemented through public and private enforcement. It is also known as antitrust l ...
, oligopolists will operate under tacit collusion, which is collusion through a mutual understanding among the competitors of a market without any direct communication or contact that by collectively raising prices, each participating competitor can achieve economic profits comparable to those achieved by a monopolist while avoiding the explicit breach of market regulations. Hence, the kinked demand curve for a joint profit-maximizing oligopoly industry can model the behaviors of oligopolists' pricing decisions other than that of the price leader (the price leader being the entity that all other entities follow in terms of pricing decisions). This is because if an entity unilaterally raises the prices of their good/service and competing entities do not follow, the entity that raised their price will lose a significant market as they face the elastic upper segment of the demand curve. As the joint profit-maximizing efforts achieve greater economic profits for all participating entities, there is an incentive for an individual entity to "cheat" by expanding output to gain greater market share and profit. In the case of oligopolist cheating, when the incumbent entity discovers this breach in collusion, competitors in the market will retaliate by matching or dropping prices lower than the original drop. Hence, the market share originally gained by having dropped the price will be minimized or eliminated. This is why on the kinked demand curve model the lower segment of the demand curve is inelastic. As a result, in such markets price rigidity prevails. Oligopoly in international trade International trade has increased from $5 trillion USD in 1994 to $24 trillion USD in 2014. Following current trends, this number will only increase in the future as an increasing of firms are now competing internationally. Different from domestic oligopolies, international oligopolies have to consider importing and exporting tariffs as countries have different international policies. This is described as “strategic trade policy” and uses both the Bertrand and Cournot models as examples of interdependence. Game theory is used when theorizing international trade theory. The added features are “That oligopolistic firms would treat markets in each country as segmented rather than integrated and the second, that countries had a motive to raise domestic welfare by shifting rents from foreign firms to the domestic economy in the form of higher domestic profits, increased government revenue or above-normal wages.” (Head & Spencer, 2017).


Modeling

There is no single model describing the operation of an oligopolistic market. The variety and complexity of the models exist because two to 10 firms can compete on the basis of price, quantity, technological innovations, marketing, and reputation. However, there are a series of simplified models that attempt to describe market behavior by considering certain circumstances. Some of the better-known models are the dominant firm model, the Cournot–Nash model, the Bertrand model and the model. As different industries have different characteristics, it is important to know which oligopoly model is more applicable for each industry. In reality, one main difference between industries is the capacity constraints. As both Cournot model and Bertrand model consist of the two-stage game, the Cournot model is more suitable for firms in industry that face capacity constraints, where firms set their quantity of production first, then set their prices. The Bertrand model is more applicable for industries with low capacity constraints, such as banking and insurance. Game theory “How to Nash equilibria in a game: 1. checking for every outcome whether at least one player could benefit from deviating; if not, NE found! 2. deriving best-response (or reaction) functions: Find best action of player for ALL feasible actions of rivals; NE at outcome where players actions are best responses to each other (i.e. where BR intersect)” (Gerlach, 2022). “Examples: - best response to confess is confess, best response to not confess is also confess - unique Nash equilibrium is outcome (confess, confess)” (Gerlach, 2022). “Multiple Nash equilibria and Pareto Dominance Criterion Definition: An Nash equilibrium Pareto dominates another equilibrium if at least one player would be better off in this equilibrium and no other player worse off. Example: Battle of the Sexes” (Gerlach, 2022). “- for both players: best response to opera is opera, best response to football is football - Nash equilibria: (football, football), (opera, opera) - (opera, opera) Pareto dominates” (Gerlach, 2022).


Cournot–Nash model

The Nash model is the simplest oligopoly model. The model assumes that there are two "equally positioned firms"; the firms compete on the basis of quantity rather than price and each firm makes an "output of decision assuming that the other firm's behavior is fixed." The market demand curve is assumed to be linear and marginal costs are constant. To find the
Nash equilibrium In game theory, the Nash equilibrium, named after the mathematician John Forbes Nash Jr., John Nash, is the most common way to define the solution concept, solution of a non-cooperative game involving two or more players. In a Nash equilibrium, ea ...
one determines how each firm reacts to a change in the output of the other firm. The path to equilibrium is a series of actions and reactions. The pattern continues until a point is reached where neither firm desires "to change what it is doing, given how it believes the other firm will react to any change." The equilibrium is the intersection of the two firm's reaction functions. The reaction function shows how one firm reacts to the quantity choice of the other firm. For example, assume that the firm 1's demand function is P = (M - Q_2) - Q_1 where Q_2 is the quantity produced by the other firm and Q_1 is the amount produced by firm 1, and M=60 is the market. Assume that marginal cost is C_M=12. Firm 1 wants to know its maximizing quantity and price. Firm 1 begins the process by following the profit maximization rule of equating marginal revenue to marginal costs. Firm 1's total revenue function is R_T = Q_1 P = Q_1 (M - Q_2 - Q_1) = MQ_1 - Q_1 Q_2 - Q_1^2. The marginal revenue function is R_M = \frac = M - Q_2 - 2 Q_1.R_M = M - Q_2 - 2Q_1. can be restated as R_M = (M - Q_2) - 2Q_1. :R_M = C_M :M - Q_2 - 2Q_1 = C_M :2Q_1 = (M - C_M) - Q_2 :Q_1 = \frac - \frac = 24 - 0.5 Q_2 .1:Q_2 = 2(M - C_M) - 2Q_1 = 96 - 2Q_1 .2 Equation 1.1 is the reaction function for firm 1. Equation 1.2 is the reaction function for firm 2. To determine the Nash equilibrium you can solve the equations simultaneously. The equilibrium quantities can also be determined graphically. The equilibrium solution would be at the intersection of the two reaction functions. Note that if you graph the functions the axes represent quantities. The reaction functions are not necessarily symmetric. The firms may face differing cost functions in which case the reaction functions would not be identical nor would the equilibrium quantities.


Bertrand model

The Bertrand model is essentially the Cournot–Nash model, except the strategic variable is price rather than quantity.Samuelson, W. & Marks, S. ''Managerial Economics''. 4th ed. page 415 Wiley 2003. Bertrand's Model can be used to explain oligopoly. Bertrand's Model thinks competition as two firms compete in the market, such as firm one and your competitors(=the rest of the market as another firm). The model assumes that firms are selling homogeneous products and therefore have the same marginal production costs, and firms will focus on competing in prices simultaneously. The idea is that after competing in prices for a while, they would eventually reach an equilibrium where the price both charge would be the same as their marginal cost of production. The mechanism behind this model is that even by undercutting just a small increment of its price, a firm would be able to capture the entire market share. The attempetion is very high and firms will have strong incentives to undercut their competitors in prices to grab the whole market profits. Even though empirical studies suggest that firms can easily make much higher profits by agreeing on charging a price that is higher than marginal costs, highly rational selfish firms would still not be able to stay at a price higher than marginal cost. It is worth noting that, Bertrand price competition is a useful abstraction of markets in many settings. Amongst many different prediction approaches, the Nash equilibrium approach has been recognised by some studies as an relatively efficient analytic tool. However, due to its lack of ability to capture human behavioural patterns, the approach has been criticised for being inaccurate in predicting prices. The model assumptions are: * There are two firms in the market * They produce a homogeneous product * They produce at a constant marginal cost * Firms choose prices P_A and P_B simultaneously * Firms outputs are perfect substitutes * Sales are split evenly if P_A = P_B The only Nash equilibrium is P_A = P_B = \text. Neither firm has any reason to change strategy. If the firm raises prices, it will lose all its customers. If the firm lowers price P < \text then it will be losing money on every unit sold. The Bertrand equilibrium is the same as the competitive result. Each firm will produce where P = \text and there will be zero profits. A generalization of the Bertrand model is the
Bertrand–Edgeworth model In microeconomics Microeconomics is a branch of mainstream economics that studies the behavior of individuals and Theory of the firm, firms in making decisions regarding the allocation of scarcity, scarce resources and the interactions among ...
that allows for capacity constraints and a more general cost function.


Cournot-Bertrand model

The Cournot model and Bertrand model are the most well-known models in oligopoly theory, and have been studied and reviewed by numerous economists. The Cournot-Bertrand model is a hybrid of these two models and was first developed by Bylka and Komar in 1976. This model allows the market to be split into two groups of firms. The first groups’ aim is to optimally adjust their output to maximise profits while the second groups’ aim is to optimally adjust their prices. This model is not accepted by some economists who believe that firms in the same industry cannot compete with different strategic variables. However, this model has been applied and observed in both real-world examples and theoretical contexts. In the Cournot model and Bertrand model, it is assumed that all the firms are competing with the same choice variable, either output or price. However, this does not always apply in real world contexts. If each firm is able to choose their own strategic variable, there would be a total of four modes of competition. The possibility of firms competing with different strategic variables is important to consider when assessing all potential market outcomes. Economists Kreps and Scheinkman's research demonstrates that varying economic environments are required in order for firms to compete in the same industry while using different strategic variables. An example of the Cournot-Bertrand model in real life can be seen in the market of alcoholic beverages. The production times of alcoholic beverages differ greatly creating different economic environments within the market. The fermentation of distilled spirits takes a significant amount of time; therefore, output is set by producers, leaving the market conditions to determine price. Whereas, the production of brandy requires minimal time to age, thus the price is set by the producers and the supply is determined by the quantity demanded at that price.


Oligopolistic market: Kinked demand curve model

According to this model, each firm faces a demand curve kinked at the existing price.Pindyck, R. & Rubinfeld, D. ''Microeconomics'' 5th ed. page 446. Prentice-Hall 2001. The conjectural assumptions of the model are; if the firm raises its price above the current existing price, competitors will not follow and the acting firm will lose market share and second, if a firm lowers prices below the existing price then their competitors will follow to retain their market share and the firm's output will increase only marginally. In other words, oligopolist's pricing logic is that competitors will match and respond to any price cut - retaliating to obtain more market share, while they will stick with the current or initial price for any price rising among competitors. If the assumptions hold, then: * The firm's marginal revenue curve is discontinuous (or rather, not differentiable), and has a gap at the kink * For prices above the prevailing price the curve is relatively elasticNegbennebor, A. ''Microeconomics: The Freedom to Choose''. page 299. CAT 2001 * For prices below the point the curve is relatively inelastic The gap in the marginal revenue curve means that marginal costs can fluctuate without changing equilibrium price and quantity, thus, prices tend to be rigid.


Examples

Many industries have been cited as oligopolistic, including
civil aviation Civil aviation is one of two major categories of flying, representing all non-military and non-state aviation Aviation includes the activities surrounding mechanical flight and the aircraft industry. ''Aircraft'' includes airplane, fixed ...
,Adriana Gama, Review of Regulating the Polluters: Markets and Strategies for Protecting the Global Environment by Alexander Ovodenko, ''Global Environmental Politics'', MIT Press, Vol. 19, No. 3, August 2019, pp. 143-145. agricultural
pesticide Pesticides are substances that are meant to control pests. This includes herbicide, insecticide, nematicide, molluscicide, piscicide, avicide, rodenticide, bactericide, insect repellent, animal repellent, microbicide, fungicide, ...
s,
electricity Electricity is the set of physics, physical Phenomenon, phenomena associated with the presence and motion of matter that has a property of electric charge. Electricity is related to magnetism, both being part of the phenomenon of electromagne ...

electricity
,Woohyung Lee, Tohru Naito & Ki-Dong Lee
Effects of Mixed Oligopoly and Emission Taxes on the Market and Environment
''Korean Economic Review'', Vol. 33, No. 2, Winter 2017, pp. 267-294: "we have witnessed mixed oligopolistic markets in a broad range of industries, such as oil, electricity, telecommunications, and power plants that emit pollutants during their respective production processes."
and platinum group metal mining.Magnus Ericsson & Andreas Tegen
Brief Report: Global PGM mining during 40 years—a stable corporate landscape of oligopolistic control
''Mineral Economics'', Vol. 29, pp. 29–36 (2016).
In most countries, the
telecommunications Telecommunication is the transmission of information by various types of technologies over wire, radio Radio is the technology of signaling and telecommunication, communicating using radio waves. Radio waves are electromagnetic waves of ...
sector is characterized by an oligopolistic market structure. Rail freight markets in the
European Union The European Union (EU) is a supranational union, supranational political union, political and economic union of Member state of the European Union, member states that are located primarily in Europe, Europe. The union has a total area of ...

European Union
have an oligopolistic structure. In the United States, industries that have identified as oligopolistic include
food processing Food processing is the transformation of Agriculture, agricultural products into food, or of one form of food into other forms. Food processing includes many forms of processing foods, from grinding grain to make raw flour to home cooking to co ...
,Rigoberto A. Lopez, Xi He & Azzeddine Azzam
Stochastic Frontier Estimation of Market Power in the Food Industries
''Journal of Agricultural Economics'', Vol. 69, Issue 1 (Feb. 2018), pp. 3-17.
funeral service A funeral is a ceremony A ceremony (, ) is a unified ritualistic event with a purpose, usually consisting of a number of artistic components, performed on a special occasion. The word may be of Etruscan language, Etruscan origin, via the Lat ...
s,
sugar refining Sugar is the generic name for Sweetness, sweet-tasting, soluble carbohydrates, many of which are used in food. Simple sugars, also called monosaccharides, include glucose, fructose, and galactose. Compound sugars, also called disaccharides o ...
, , pulp and paper making,
Market power In economics Economics () is the social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behav ...
and
market concentration In economics, market concentration is a function (mathematics), function of the number of :wikt:firm, firms and their respective Market share, shares of the total production (alternatively, total capacity or total reserves) in a Market (economics ...
can be estimated or quantified using several different tools and measurements, including the
Lerner index The Lerner index, formalized in 1934 by British economist of Russian origin Abba Lerner, is a measure of a firm's market power. Definition The Lerner index is defined by: L=\frac where P is the market price set by the firm and MC is the firm's ...
,
stochastic frontier analysis Stochastic frontier analysis (SFA) is a method of economic modeling. It has its starting point in the stochastic Stochastic (, ) refers to the property of being well described by a random probability distribution. Although stochasticity and ...
, and New Empirical Industrial Organization (NEIO) modeling, as well as the Herfindahl-Hirschman index.


Possible outcomes of Oligopoly

One possible outcome of oligopoly is the maintaining of a steady price as a result of a curve. Firms in this situation concentrate their efforts on
non-price competition Non-price competition is a marketing strategies, marketing strategy "in which one firm tries to distinguish its product (business), product or Service (economics), service from Competition, competing products on the basis of attributes like design ...
. The curve model suggests that prices would be relatively stable, and that firms will have little motivation to adjust their pricing in the near future. As a result, firms compete using strategies other than price competition. The firms participating in this market system are motivated by the desire to maximize their profits. Profit would be maximized at \text = \text. Firms would earn a significant rise in market share if they reduced their prices. Although it is possible, it is doubtful that firms will accept this. As a result, other firms follow suit and reduce their prices as well. Because of this, demand will only grow by a marginal amount. As a result, demand for a price reduction is inelastic. It is likely that they will lose a significant portion of the market if they raise the price, since they would become uncompetitive when compared to other firms. As a result, demand is very elastic in response to price increases. Rather than assuming price rigidity, kinked demand strategies serve as a mechanism for enforcing compliance with a collusive price leadership strategy. Another possible outcome of oligopoly is the
price war A price is the (usually not negative) quantity of payment or Financial compensation, compensation given by one Party (law), party to another in return for Good (economics), goods or Service (economics), services. In some situations, the pr ...
. However, despite suggestions that pricing wars might be unproductive for the business, Schendel and Balestra contend that at least some players in a
price war A price is the (usually not negative) quantity of payment or Financial compensation, compensation given by one Party (law), party to another in return for Good (economics), goods or Service (economics), services. In some situations, the pr ...
can profit from their participation. Oligopolies can nevertheless have fierce pricing competition among their members, especially if they want to expand their market share. Oligopolies exist when firms compete with one another to reduce costs and gain market share. A common aspect of oligopolies is the ability to engage in price competition selectively. When it comes to bread and special offers, supermarkets often fight on price, but when it comes to product such as yogurt, they charge a premium.


Demand curve

In an oligopoly, firms operate under
imperfect competition In economics, imperfect competition refers to a situation where the characteristics of an economic market do not fulfil all the necessary conditions of a perfectly competitive market. Imperfect competition will cause market inefficiency when it happ ...
. With the fierce price competitiveness created by this sticky-upward
demand curve In economics, a demand curve is a Graph of a function, graph depicting the relationship between the price of a certain commodity (the ''y''-axis) and the quantity of that commodity that is demanded at that price (the ''x''-axis). Demand curves can ...

demand curve
, firms use
non-price competition Non-price competition is a marketing strategies, marketing strategy "in which one firm tries to distinguish its product (business), product or Service (economics), service from Competition, competing products on the basis of attributes like design ...
in order to accrue greater revenue and market share. "Kinked" demand curves are similar to traditional demand curves, as they are downward-sloping. They are distinguished by a hypothesized convex bend with a discontinuity at the bend–"kink". Thus, the first
derivative In mathematics Mathematics is an area of knowledge that includes the topics of numbers, formulas and related structures, shapes and the spaces in which they are contained, and quantities and their changes. These topics are represented ...

derivative
at that point is undefined and leads to a jump discontinuity in the marginal revenue curve. Classical
economic theory Economics () is the social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behaviour and intera ...

economic theory
assumes that a profit-maximizing producer with some market power (either due to oligopoly or
monopolistic competition Monopolistic competition is a type of imperfect competition such that there are many producers competing against each other, but selling products that are differentiation (economics), differentiated from one another (e.g. by branding or qualit ...
) will set marginal costs equal to marginal revenue. This idea can be envisioned graphically by the intersection of an upward-sloping marginal cost curve and a downward-sloping marginal revenue curve (because the more one sells, the lower the price must be, so the less a producer earns per unit). In classical theory, any change in the marginal cost structure (how much it costs to make each additional unit) or the marginal revenue structure (how much people will pay for each additional unit) will be immediately reflected in a new price and/or quantity sold of the item. This result does not occur if a "kink" exists. Because of this jump discontinuity in the marginal revenue curve,
marginal cost In economics, the marginal cost is the change in the total cost that arises when the quantity produced is incremented, the cost of producing additional quantity. In some contexts, it refers to an increment of one unit of output, and in others it r ...

marginal cost
, s could change without necessarily changing the price or quantity. The motivation behind this kink is the idea that in an oligopolistic or monopolistic competitive market, firms will not raise their prices because even a small price increase will lose many customers. This is because competitors will generally ignore price increases, with the hope of gaining a larger market share as a result of now having comparatively lower prices (price rigidity). However, even a large price decrease will gain only a few customers because such an action will begin a
price war A price is the (usually not negative) quantity of payment or Financial compensation, compensation given by one Party (law), party to another in return for Good (economics), goods or Service (economics), services. In some situations, the pr ...
with other firms. The curve is, therefore, more price-elastic for price increases and less so for price decreases. Theory predicts that firms will enter the industry in the long run since market price for oligopolists is more stable or 'focal' in the long run under this kinked demand curve situation.


See also

*
Big business Big business involves large-scale corporate-controlled financial market, financial or business sector, business activities. As a term, it describes activities that run from "huge transactions" to the more general "doing big things". In corporate ...
*
Conjectural variation In oligopoly theory, conjectural variation is the belief that one firm has an idea about the way its competitors may react if it varies its output or price. The firm forms a conjecture about the variation in the other firm's output that will accompa ...
*
Market failure In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value. Market failures can be viewed as scenarios where indiv ...
*
Monopoly A monopoly (from Greek language, Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none), as described by Irving Fisher, is a market with the "absence of competition", creating a situati ...

Monopoly
*
Monopsony In economics, a monopsony is a market structure in which a single buyer substantially controls the market as the major purchaser of goods and services offered by many would-be sellers. The Microeconomics, microeconomic theory of monopsony assumes ...
* Oligopolistic reaction *
Oligopsony An oligopsony (from Greek Greek may refer to: Greece Anything of, from, or related to Greece, a country in Southern Europe: *Greeks, an ethnic group. *Greek language, a branch of the Indo-European language family. **Proto-Greek language, the a ...
*
Perfect competition In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In Economic model, theoret ...
*
Planned obsolescence In economics and industrial design, planned obsolescence (also called built-in obsolescence or premature obsolescence) is a policy of planning or designing a good (economics), product with an artificially limited Product lifetime, useful life o ...
*
Prisoner's dilemma The Prisoner's Dilemma is an example of a game analyzed in game theory. It is also a thought experiment that challenges two completely Rationality#Economics, rational Agent-based model, agents to a dilemma: cooperate with their partner for mutu ...

Prisoner's dilemma
* Simulations and games in economics education *
Swing producer A swing producer or swing supplier is a supplier or a close oligopoly, oligopolistic group of suppliers of any commodity, controlling its global deposits and possessing large spare production capacity. A swing producer is able to increase or decreas ...
*
Unfair competition Unfair may refer to: * Double Taz and Double LeBron James in multiverses ''wikt:fair, fair''; wikt:unfairness, unfairness or injustice * Unfair (TV series), ''Unfair'' (drama), Japanese television series * ''Unfair: The Movie'' * Unfair (song), a s ...


Notes


References

Gerlach, H. (2022). Section 2 - Basic Concepts. Lecture, Brisbane; University Queensland.


Further reading

* Bayer, R. C. (2010)
Intertemporal price discrimination and competition
''Journal of economic behavior & organization'', ''73''(2), 273–293. *Harrington, J. (2006). Corporate leniency programs and the role of the antitrust authority in detecting collusion. ''Competition Policy Research Center Discussion Paper, CPDP-18-E''. *Ivaldi, M., Jullien, B., Rey, P., Seabright, P., & Tirole, J. (2003). The economics of tacit collusion. {{DEFAULTSORT:Oligopoly Market structure