- A market in which a few firms produce all or most of the
market supply of a particular good or service.
|How Do We Know When an Oligopoly Exists?
- by measuring market power
- we use the Concentration Ratio - the proportion of total
output produced by the largest firms (usually the four largest).
- the concentration ratio is a measure of market power that
relates the size of firms to the size of the market.
market power is not necessarily associated with firm size – in
words, a small firm could possess a lot of power in a relatively small
- potential measurement problems:
- a high ratio or large firm size is not the only way
achieve market power. Many smaller firms acting in unison can
the same result.
- measurements do not convey the extent to which market
power may be concentrated in a local market.
- Market structure affects market behavior and outcomes.
- The Battle for Market Share
- Market share - the percentage of total market
output produced by a single firm
- In an oligopoly, increased sales on the part of one firm
will be noticed immediately by the other firms.
- Increase Sales at the Prevailing Market Price -
in the market share of one oligopolist necessarily reduce the shares of
- Increased Sales at Reduced Prices – Increases in sales
to lowering the price may expand total market sales and increase the
of an individual firm without affecting the sales of its competitors.
there simply isn’t any way that a firm can do so without causing all
alarms to go off in the industry.
- Oligopolists respond to aggressive marketing by
Price competition is typically self-defeating in an
An attempt by one oligopolist to increase its market
by cutting prices will lead to a general reduction in the market price.
- Stepping up marketing efforts.
- Cutting prices on their product(s).
|The Kinked Demand Curve
- Price Reductions
- the degree to which sales increase when the price is
reduced depends on the response of rival oligopolists.
- we expect oligopolists to match any price reductions by
- Price Increases
- rival oligopolists may not match price increases in an
attempt to gain market share.
- the shape of the demand curve facing an oligopolist
on the responses of its rivals to a change in the price of its own
- the demand curve will be kinked if rival oligopolists
match price reductions but not price increases.
|The Herfindahl-Hirschman Index
- The Herfindahl-Hirschman Index (HHI) is a measure of
industry concentration that accounts for number of firms and size of
- HHI of market concentration = the sum of the
squares of the market shares of each firm in an industry.
- For policy purposes, the Justice Department decided it
would draw the line at a value of 1,800.
- Game theory is the study of decision-making in situations
strategic interaction (moves and countermoves) between rivals occurs.
- each oligopolist has to consider the potential responses of
rivals when formulating price or output strategies.
- the strategic option each oligopolist confronts are
summarized in Table 25.4
- the payoff to an oligopolist’s price cut depends on how
its rivals respond.
- if a firm does not reduce its price, it cannot increase
- the collective interests of the oligopoly are protected
no one cuts the market price, but an individual
could lose if it holds the line on price when rivals
- risk assessment is the foundation of game theory
|Oligopoly vs. Competition
- Price and Output
- an oligopoly will want to behave like a monopoly,
choosing a rate of industry output that maximizes total industry profit.
- Sticky Prices
- prices in oligopoly industries tend to be stable.
- oligopolists want to maximize profits by producing
where MR = MC
- the kinked demand curve is really a composite of two
separate demand curves.
- there is a gap in an oligopolist’s marginal revenue curve.
- consequently, modest shifts of the cost curve will have
no impact on the production decision of an oligopolist.
- There is an inherent conflict in the joint and individual
interests of oligopolists. The two goals that conflict are:
- Each oligopolist wants the industry profits to be
- Each oligopolist wants to maximize its own market
However, doing so can lower the industry’s profits as other
match price cuts designed to do just that.
- Explicit agreements among producers regarding the
price(s) at which a good is to be sold.
Allocation of Market Shares.
- An oligopolistic pricing pattern that allows one firm to
establish the (market) price for all firms in the industry.
- when a monopolist raises his prices, he can adjust with a
in output. However, when oligopolists raise their prices, they
to deal with how the loss of output will be distributed among them.
- Cartel - a group of firms with an explicit agreement to
fix prices and output shares in a particular market.
- When market shares are not being divided in a manner
satisfactory to an oligopolist, he may take drastic action such as predatory
- this is temporary price reductions designed to alter
market shares or drive out competition.
|Barriers to Entry
- To keep potential competitors out of their industry,
oligopolists must maintain barriers to entry.
- WHY? ==> because above-normal profits cannot
be maintained unless barriers to entry exist
- Patents – Prevent potential competitors from setting up
until they either develop an alternative method for producing a product
receive permission from the patent holder to use the patented process.
- Distribution Control - A firm can provide a barrier to
entry by taking control of the distribution outlets.
Mergers and Acquisition
- Visa and MasterCard prevent banks that issue their
credit cards from offering rival cards.
- Frito-Lay elbows out competing snacks by paying high
fees to “rent” shelf space in grocery stores.
- a firm can limit competition by acquiring
competitors through mergers and acquisition.
Nonprice Competition - Advertising not only strengthens
loyalty, but also makes it expensive for new producers to enter the
Training - Early market entry can create an important
to later competition. Customers of training-intensive products (e.g.
hardware and software) become familiar with a particular system.
switch to a different product may entail significant cost. This
is a barrier to entry to any competing product trying to enter the
Network Economies – the widespread use of a particular
may heighten its value to consumers, thereby making potential
less viable. For example, software developers prefer to write
based programs rather than for rival operating systems.
- Patents are issued by the federal government.
- Licensing requirements imposed by government limit
- Barriers to international trade are another
government-imposed barrier to entry.
- Restrictions on the number of cabs licensed in a city
is another form of government restriction to market entry.