Prices Under an Oligopoly
Oligopoly is a market structure, which has some distinctive qualities that separate it from the others. Most notably they are that oligopoly has barriers of entry and is made of only a few companies, which supply the majority of the market and are interdependent. In other market structures price of the product and other decisions are often based on technical information such as marginal cost or demand (when you are a monopoly) but what makes oligopoly unique from all other market structures is that companies cannot base their decisions solely on technical information they must be aware of and react to their competitors.
Oligopoly is also a distinctive market structure because price is not usually used as a competitive tool. There are exceptions of oligopolies that engage in price wars, for example AMD and Intel, semiconductor producers, both use fierce price lowering tactics because when one of them decreases their price of a product the other has nothing else to do but follow in order not to loose a big market share. Intel and AMD price wars are beneficial to the consumers but not to the companies which each year miss their target revenues and get lower profits. Relatively stable prices under oligopoly, which are called sticky prices or rigid prices, is a strong feature of this market structure and this essay will try to explain why such prices exist.
This essay will analyze situations when companies do not coordinate their actions (Non-collusive behavior) and when they do, implicitly (tacit collusion) and explicitly (formal collusion).
I. Non-collusive behavior
Non-collusive behavior is when companies do not coordinate their actions but still react to their competitors. In 1939 Robert Hall and Charles Hitch in UK and Paul Sweezy in USA individually presented a kinked demand curve, which demonstrates a reason why oligopolies do not what to change prices. The kinked demand curve (fig. 1) graph is hypothetical because companies will try to restrain from changing their prices. If a company raises its price, represented in the graph by the demand curve AA then their competitors presumably will not follow them and the first company looses customers. If a company decides to lower its price, represented by BB their competitors will have no choice but to also decrease their prices which would not be beneficial for every company in the market. The demand curve for a company is fused from AA and BB demand curves and has a kink at point P, though it is not exactly clear where the kink occurs exactly.
Best Buy operates in an oligopolistic market where there are significant barriers to entry and few large firms dominate the market by selling identical goods. Best Buy is a non-collusive oligopolist, existing in a strategic environment where firms do not cooperate, yet are interdependent due to the fact that a firm’s action affects the market. Recently, Best Buy experienced an increase in demand, increasing its revenues and profits.
This organization belongs to the oligopoly market structure. The oligopoly market structure involves a few sellers of a standardized or differentiated product, a homogenous oligopoly or a differentiated oligopoly (McConnell, 2004, p. 467). In an oligopolistic market each firm is affected by the decisions of the other firms in the industry in determining their price and output (McConnell, 2005, P.413). Another factor of an oligopolistic market is the conditions of entry. In an oligopoly, there are significant barriers to entry into the market. These barriers exist because in these industries, three or four firms may have sufficient sales to achieve economies of scale, making the smaller firms would not be able to survive against the larger companies that control the industry (McConnell, 2005, p.
An oligopoly is a market structure in which a few firms dominate. When a market is shared between a few firms, it is said to be highly concentrated. Although only a few firms dominate, it is possible that many small firms may also operate in the market.
In the Beverage Industry Coca-Cola owns approximately 42% of the Industry where as Pepsi Co. owns approximately 30%. Since 1886, Coca-Cola has been present in the market where as Pepsi Co. entered the market 13 years later. Oligopolies perpetuate themselves and discourage new investments in several ways. One example is having access to key resources, whether it’s natural resources or patented process or special knowledge. This creates difficulty for new firms to enter the industry without access to those resources. In addition with experience of keeping cost low, oligopolies benefit significantly in cost advantages which discourages new firms from entering. An example of this would be a new firm attempting to attract new consumers with a new product rather than an established product. With having an established product oligopolies are able to obtain lower prices from supplies thus allowing them to create predatory pricing aimed at driving smaller competitors out of business. Since they are the two dominant market holders in the Beverage Industry they acquire most of the sales volume. This allows the companies to reduce prices on their products to discourage new firms to continue as they will have to follow the trend. In contrast they increase prices to remain in the market and protect their industry from the expansion or interest of other
As, perfect competitive, where there are many firm competing, none of which is large and freedom to entry and all firm products are homogenous products. Slomans, Wride and Garatt (2012) states firms are price takers. There are so many firms in the industry that each one producers an insignificantly small portion of total industry supply , and therefore has no power whatsoever to affect the price of the product since if firms rise the price, customers can choose another firm to consume which are lots of firm in market. Therefore, it faces a horizontal demand ‘curve’ at the market price: the price determined by the interaction of demand and supply in the whole market.
An oligopoly usually consists of two to ten companies that are selling products with little to no differentiation. While the companies do hold some control over the price of the product they are selling, it is mostly dependent of the pricing of the competitors’ product. The companies in an oligopoly rely heavily on advertising and marketing their products to appeal to consumers. This is because all the companies in the oligopoly have to try to stay a step ahead of their competitors in order to appeal to consumers (S, S.). An example of an oligopoly is the cell phone industry. Verizon, AT&T, Sprint, and T-Mobile are the four dominating competitors in the market. These four companies are the only ones offering a reliable plan, at a (not so) decent price. They are constantly advertising, it seems as if every other commercial and ad you see is for one cell phone company or another, for one outrageously expensive plan or another. This goes to show that just because there is some semblance of competition between companies in a market, does not mean that consumers will be receiving a fair price on a product or
When a monopoly occurs because it is more efficient for one firm to serve an entire market than for two or more firms to do so, because of the sort of economies of scales available in that market. A common example is water distribution, in which the main cost is laying a network of pipes to deliver water.
Because there are few firms in an oligopoly industry, each firms output is a large share of the market. As a result, each firm's pricing and output decisions have a substantial effect on the profitability of other firms. In addition, when making decisions relating to price or output, each firm has to take into consideration the likely reaction of rival firms. Because of this interdependence, oligopoly firms engage in strategic behaviour. Strategic behaviour means when the best outcome of a firm is determined by the actions of other firms.
It is a well-known fact that every firm wants to be successful in its business. Sometimes it is difficult to decide what kind of actions to take in order to achieve it. Especially, it is hard on oligopoly market because this is one of the most complicated market structures. Oligopoly includes many models and theories such as duopoly where are just two producers and which pricing decisions remind monopoly, kinked demand curve, which decreases economic profit, and cartel, which brings economic profit just for the short-run. However, to be a successful oligopolistic firm in the long run, managers should include in the planning process such economic theories and models as producer interdependence, the prisoner’s dilemma, price leadership, nonprice adjustments, and correct using of barriers to entry.
Philip M. Parker and Lars-Hendrik Röller. (1997). Collusive Conduct in Duopolies: Multimarket Contact and Cross-Ownership in the Mobile Telephone Industry. The RAND Journal of Economics. Vol. 28 (2), pp. 304-322
An oligopolistic market has a small number of sellers dominating market share and therefore barriers to entry are high. These sellers are highly competitive and do not act independently of each other. Access to information is limited so sellers can only speculate of their competitor’s actions. Sellers will take advantage of competitor’s price changes in order to increase market share.
An oligopoly is defined as "a market structure in which only a few sellers offer similar or identical products" (Gans, King and Mankiw 1999, pp.-334). Since there are only a few sellers, the actions of any one firm in an oligopolistic market can have a large impact on the profits of all the other firms. Due to this, all the firms in an oligopolistic market are interdependent on one another. This relationship between the few sellers is what differentiates oligopolies from perfect competition and monopolies. Although firms in oligopolies have competitors, they do not face so much competition that they are price takers (as in perfect competition). Hence, they retain substantial control over the price they charge for their goods (characteristic of monopolies).
The Perceived Demand Curve for a Perfect Competitor and Monopolist (Principle of Microeconomics, 2016). A perfectly competitive firm (a) has multiple firms competing against it, making the same product. Therefore the market sets the equilibrium price and the firm must accept it. The firm can produce as many products as it can afford to at the equilibrium price. However, a monopolist firm (b) can either cut or raise production to influence the price of their products or service. Therefore, giving it the ability to make substantial products at the cost of the consumers. However, not all monopolies are bad and some are even supported by the
Markets have four different structures which need different "attitudes" from the suppliers in order to enter, compete and effectively gain share in the market. When competing, one can be in a perfect competition, in a monopolistic competition an oligopoly or a monopoly [1]. Each of these structures ensures different situations in regards to competition from a perfect competition where firms compete all being equal in terms of threats and opportunities, in terms of the homogeneity of the products sold, ensuring that every competitor has the same chance to get a share of the market, to the other end of the scale where we have monopolies whereby one company alone dominates the whole market not allowing any other company to enter the market selling the product (or service) at its price.
The second market structure is a monopolistic competition. The conditions of this market are similar as for perfect competition except the product is not homogenous it is differentiated; thus having control over its price. (Nellis and Parker, 1997). There are many firms and freedom of entry into the industry, firms are price makers and are faced with a downward sloping demand curve as well as profit maximizers. Examples include; restaurant businesses, hotels and pubs, specialist retailing (builders) and consumer services (Sloman, 2013).