Download 2.3.10 Oligopoly (Revisited)

Module 2: Theory of the Firm
2.3.10 – Oligopoly (Revisited)
2.3.10 Oligopoly (Revisited)
The Nature of Oligopoly / Assumptions of the Model
 Oligopoly is a market form in which there are only a few firms in the industry with
many buyers.
 The market supply will be concentrated in the hands of relatively few producers,
although an industry might still be said to be oligopolistic where several smaller
firms existed alongside the few large firms that dominate.
 The markets for motor vehicles, airline carriers, and supermarket chains all provide
good examples of oligopoly.
 Where the few firms produce an identical product, this is known as perfect
oligopoly.
 Where, more commonly, the products are differentiated, this is referred to as
imperfect oligopoly.
 Duopoly is where there are only two firms in the industry.
 In oligopoly, where there is competition amongst the relatively few, each firm has
to also try to assess the reaction of its rivals to a change in price, as each firm will
occupy a sufficiently important position within the industry for its particular price
and output decisions to have a significant impact on its competitors.
 Thus if an oligopolist is thinking of raising the price of its product, it has to assess
whether its rivals will do likewise or keep price down in order to gain more
custom.
 Oligopoly is therefore characterized by interdependence between the firms that
comprise the industry, and by reactive market behaviour.
 Oligopoly has emerged as the most prevalent market form.
 This can partly be explained by the existence of economies of scale, especially in
manufacturing, encouraging the growth of large-scale production.
o As firms grow in size, the number of firms supplying the market falls, and
hence the tendency towards oligopoly power.
o Moreover, once established, this power may be sustained by various barriers
to entry, similar to those that exist under monopoly.
The Importance of Non-price Competition
 An important feature of oligopolistic markets is the tendency towards relative price
stability.
 Lack of price movement will occur most obviously where firms collude with each
other to collectively fix their prices.
 It may also occur in a situation of non-collusive oligopoly where no such price
agreements exist, but interdependent firms may well come to the conclusion that
there is no point in engaging in price wars in the long term as this could be
disastrous for all firms.
 The absence of price competition does not mean an absence of competition:
o Oligopolistic firms are likely to compete in a variety of non-price forms.
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Module 2: Theory of the Firm
2.3.10 – Oligopoly (Revisited)
 Non- price competition occurs where firms attempt to win a competitive advantage
over their rivals by strategies other than reducing prices.
 Non-price competition inevitably involves product differentiation.
 Oligopolistic competitors try to carve out separate markets in which they can
command consumer loyalty through the creation of actual or imagined differences
in the goods or services they offer.
 Products are differentiated from one another in a variety of ways, including shape,
size, quality and image.
 Examples of Non-price Competition:
o Advertising
o Branding
o Product innovation
o Packaging
o The provision of after sales services e.g. product guarantees
o Free samples and gift offers
Advertising
 Advertising can be informative or persuasive.
 The following table provides a summary of the potential advantages and
disadvantages of advertising to consumers, firms and the economy as a whole:
Advantages
For consumers Acts as a medium of
communication between buyers
and sellers, provides information
on product availability and
facilitates wider choice
May lead to lower prices if (a)
larger sales and production levels
result in economies of scale and
lower unit costs (b) the advertising
is based on price competition
Disadvantages
Persuasive advertising may render
consumer choice irrational and destroy
consumer sovereignty
Through its portrayal of a fantasy,
largely affluent world, it creates
unnecessary wants by generating
feelings of inadequacy and greed
May lead to higher prices because (a)
there may be higher costs, particularly
if economies of scale are not achieved
(b) advertising may act as a barrier to
entry of new firms and thus increase
monopoly power, particularly where
established firms engage in saturation
advertising which cannot be matched
by smaller firms
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Module 2: Theory of the Firm
2.3.10 – Oligopoly (Revisited)
For firms
For the
economy as a
whole
If successful, advertising will (a)
shift the demand curve to the right
and (b) make the demand curve
more inelastic.
Lower profits if costs of production are
increased without raising sufficient
extra revenue, or without shifting the
demand curve making demand more
inelastic
It may enable firms to maintain
their monopoly power through the
creation of brand loyalty and
barriers to entry
Greater profits may be earned if
higher sales and output levels lead
to economies of scale and lower
costs
A greater level of employment if Advertising may lead to a misallocation
the level of sales and production
of society's scarce resources as the
increase
pattern of production may reflect the
skill of the advertisers in manipulating
consumers' tastes, rather than what
consumers actually want / need.
Certain sectors of the economy
The generation of negative externalities
only survive because of the
through tasteless or unsightly
revenue which advertising earns
advertising
e.g. commercial radio, newspapers
and magazines
Branding:
 The main aim of branding is to make particular goods, produced by particular
firms, appear as if they have unique features, which the products of competing
firms do not possess.
 The difference, real or imagined, in how consumers perceive branded products,
may be sufficient to allow goods to be sold at very different prices.
 Branding serves as a very effective barrier to entry of new firms.
Product Innovation:
 Rival firms may attempt to gain a larger slice of the market by constantly seeking
to improve the quality and/or style of their existing products, or by developing
entirely new products.
 This innovation usually has to be backed by extensive research and development.

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