Oligopoly

Kinked demand

Oligopoly is a market structure characterized by a small number of firms that dominate the market. This situation is distinct from a monopoly, where only one company controls the entire market, and perfect competition, where many firms are competing, each with a negligible share of the market. In an oligopoly, each firm has significant market power, and their decisions regarding prices, production, and other strategic factors can have a substantial impact on the competitive landscape.

Characteristics

The main characteristics of an oligopoly include:

• Limited Competition: There are few sellers in the market, making the actions of each firm influential on the others.
• Interdependence: Firms in an oligopoly are highly dependent on the actions of others when making strategic decisions, such as setting prices or output levels.
• Barriers to Entry: High entry barriers exist, which can be economic, technological, legal, or due to strong brand identity, preventing new competitors from easily entering the market.
• Product Differentiation: Products may be differentiated or homogeneous. In some oligopolies, firms offer products that are close but not perfect substitutes, leading to non-price competition.

Types of Oligopoly

Oligopolies can be categorized based on the nature of the product and the competition within the market:

• Homogeneous Oligopoly: Firms produce a standardized product, often seen in industries like steel or oil.
• Differentiated Oligopoly: Companies offer products that are distinct but serve a similar purpose, allowing for non-price competition. This is common in the automobile and consumer electronics industries.

Models of Oligopoly Behavior

Several models attempt to explain how firms in an oligopoly set prices and output:

• Cournot Model: Assumes firms compete on quantity, deciding how much to produce independently, with the market price adjusting based on the total output.
• Bertrand Model: Assumes firms compete on price, with each firm choosing its price independently, potentially leading to a price war.
• Kinked Demand Curve: Suggests that a firm will face a more elastic demand curve if it tries to increase its price, while a decrease in price will be matched by competitors, leading to a rigid demand curve around the current price.

Implications of Oligopoly

Oligopolies can lead to various market outcomes:

• Price Stability: Due to the interdependence of firms, prices may be more stable in an oligopoly than in more competitive markets.
• Collusion: Firms may engage in collusion, either explicitly through cartels or implicitly, to control prices and limit competition, which can lead to higher prices for consumers.
• Innovation: The competition in differentiated oligopolies can lead to innovation as firms seek to gain a competitive edge through unique products or services.

Regulation

Governments may regulate oligopolies to prevent anti-competitive behavior and protect consumers. This can include antitrust laws, price controls, and measures to increase market transparency and competition.