The Main Features of an Oligopoly Market - Essay Example

Name : xxxxxxxxxxx Institution : xxxxxxxxxxx Course : xxxxxxxxxxx Title : Oligopoly market Tutor : xxxxxxxxxxx @2009 Table of Contents Introduction 3 The assumptions of oligopoly consist of: 3 Features of oligopoly markets 4 Diagram and theory with kinked demand curve 5 Kinked demand curve under oligopoly 6 Collusive oligopoly 9 Pure oligopoly with homogeneous product 9 Impure oligopoly with differentiated product 9 Price wars examples and non price competition examples 10 Price wars 10 Non-price competition 10 Conclusion 11 Bibliography 11 The Main Features Of An Oligopoly Market And How The Firms In These Markets Attempt To Compete With Each Other. Introduction Oligopoly is a market form whereby a market is governed by a small number of traders. Since there is small number of sellers, all oligopolies have a possibility of being aware of the action of the other traders. The decisions of one firm influence, and are controlled by, the decisions of other firms. Strategic planning by the oligopolies requires taking into consideration the probable responses of the other market partakers. This makes oligopoly markets and industries to encounter a high risk for collusion. In other words, oligopoly refers to competition among the few and hence a market is concluded to be oligopoly where supply is led by a small number of producers whereby each has got some control over the market (Lynk 2002). The assumptions of oligopoly consist of: There are profit maximization conditions since an oligopoly capitalizes on profits through making productions where marginal profits are the same as marginal expenses. Supply of goods ought to be concentrated in the hands of comparatively small number of firms. There are very few firms that the action of a single firm affects other firms. Firms are mutually dependent which differs with other markets because the other markets structures firms are self-determining. The business firms produce alike products, which are distinguished through branding of the products. There are barriers to entry within the oligopoly industry. The most significant barriers are economies of scale, copyrights, accessing costly and complicated technology and calculated actions by serving firms designed to depress or wipe out emerging firms. Long Run Profits, Oligopolies can maintain long run unusual profits. Many barriers of entry avert other firms from entering market to get surplus profits. Some of the examples of oligopoly markets are chemical industry, banks and building societies, petrol retailing and production and telecommunications industry. One example is that of three petrol stations (A, B and C) located at close location. If petrol station A reduces the price of its petrol per galloon, other petrol stations, B and C will also reduce their prices because failure to reduce the prices will risk them losing their business to petrol station A (Leverhulme Centre for Research 2005). Features of oligopoly markets These markets have non price competition. This means in oligopoly markets price is not the most significant feature within the competitive process. It is the firms that decide regarding the marketing mix and afterward compete in all other areas. For example firms compete through branding which is giving the product its own identity to differentiate it from the other products. Another feature is that in these markets there is price rigidity. Prices in oligopoly usually change much less frequently than in ideal competition. Even when the expenses change within oligopoly markets, prices tend to remain constant. Still, the markets have L shaped average cost curves. This means that in these markets, AC curves are in most cases L shaped than U shaped within oligopoly markets. The oligopoly markets also tend to experience collusion. Within oligopoly firms, they regularly attempt to collude which means they cooperate. This is in terms of price and separate up the markets so that both firms can encounter the benefits. The firms collude regularly in attempt to even out the unstable markets. They do this to lessen the risks intrinsic within these markets for investments and development of the product. It is not always necessary to have formal agreements in order for collusion to transpire. For instance, in some industries, there could be an accredited market leader which casually lays down the prices to which other producers respond to and this is referred to as price leadership (Tucker 2004). For example, In UK, four firms chare 74.4 % of the grocery market and they include Tesco, Asda, Morrisons and Sainsbury’s firm while the detergent market in UK has been dominated by two firms namely Unilever and Procter & Gamble. Diagram and theory with kinked demand curve In oligopoly, firms run through imperfect competition. The theory presumes that a producer aiming at maximizing the profits with some market power will determine the marginal costs equivalent to marginal profits. The more the firm sells, the lesser the price should be and so the less the firm gets per unit. Any change regarding how much it costs to produce every extra unit or a change in how much customers will pay for every extra unit will be instantly indicated in a new price or amount sold of the product. This does not happen if a kink occurs. Due to the jump discontinuity within the production costs and customer’s payment can change without essentially changing the price or amount. There are several model of oligopoly which tries to expound how the market functions. The most frequent model in these markets is kinked demand curve model. Kinked demand curve under oligopoly Oligopolist experiences a downward sloping demand curve though the elasticity can be dependant on the reaction of competitors to change in price and output. Presuming that firms are trying to retain high profits and their market share it might be the case that: Competitors will not follow a price rise by one firm and consequently demand will be comparatively elastic and an increase would result in the total profits of the firm. Competitors are more liable to match a price decrease by one firm to evade a loss market share. If this occurs, demand will be more inelastic and a decrease in price will also result in total profits. The kink within the demand curve at price P and output Q demonstrates that there is a discontinuity in the firm's marginal revenue curve. If it is presumed that the marginal cost curve in is cutting the MR curve then at this point, the firm is maximising profits. In the diagram below, it illustrates that increase in marginal costs will not essentially result into elevated prices as long as that the new MC curve (MC2) cuts the MR curve at equivalent output. The kinked demand curve theory proposes that there will be price tackiness in these markets and that firms will depend more on non-price competition to increase sales, revenue and profits. Types of oligopoly Collusive oligopoly At time, oligopolies collude in a cartel. They cooperate with each other to control the market and maintain the prices high. When cartel is in operation, it is more or less like monopoly. The firms do not compete since they fear that competing directly will destroy all of them and therefore when acting they consider the reaction of other oligopolies. Because the firms are not sure of how each firm will behave, either deceive on cartel to make huger profits or not, the performance of the oligopolies is difficult to foresee. When firms recognize that cartel is not working out and some firms are breaking the rules and deceiving, a price war comes in. Oligopolies will manufacture and price much as an entirely competitive industry would; at times they operate like a monopoly. Pure oligopoly with homogeneous product Homogenous product implies that the firm produces the same product with another different firm. The products are not as many as differentiated products for instance wheat, diamond, steel and many others. The products are all homogenous since there are very small differences among the products. Even if the homogenous products are similar differentiated products from different firms, there still can be many variations between each product. Impure oligopoly with differentiated product In this type of oligopoly, there is competition among a small number of producers of products which are alike according to the customers however not identical. There is rivalry between producers of products that are differentiated. Here, oligopoly is considered as a general market condition. Some examples within national markets consist of the automobile industry, the beer industry and the oil industry (Papandreou1998). Price wars examples and non price competition examples Price wars Whereas the price in oligopoly markets in most cases appears stable, at other times they turn out to be highly unstable. At times, firms within the oligopoly markets take on in price wars whereby when one firm reduces the price so low in attempt to wipe out its rivals and consequently gain market share. This is very regular when the demand of the product is decreasing. For example: In Newspaper industry. The mirror newspaper started a price war with other tabloids in an effort to raise market share. It reduces its price from 38p to 20p, on the other hand the Sun soon followed the suit reducing its price to 20p and consequently in the long run both firms lost money. Non-price competition The subsistence of price wars is proof of competition within oligopoly markets. Nonetheless, even the times when the prices are stable, this does not imply that there is no competition at all. There is non-price competition among the firms within oligopoly which is normally very intense. Examples of non-price competition include product branding, product advertisement, product placement, promotion of the product, free gifts and product endorsement. The firm offering 40 extra free is not an example of non price competition because the customer gets more for equal price and hence the average price decreases (Hartley 2008). Conclusion The model is very important in explaining oligopoly markets since it helps explain why the prices are rigid within oligopoly. Even when the costs change, the price does not change. Nevertheless, there are several weaknesses within the model which include: The model does not explain how the original price of the firms’ product was reached at, the model also ignores the effect of non-price competition and the model presumes a certain reaction by other firms to a change in the price of firm A. Within the real world, it is unlikely that firms will react in this manner. Bibliography Hartley, K., 2008, Microeconomic policy: a new perspective, Edward Elgar Publishing, New York. Leverhulme Centre for Research, 2005, Intra- and inter-firm technology transfer in an international oligopology, Leverhulme Centre for Research on Globalization and Economic Policy, California. Lynk, L., 2002, Industrial organization: competition, growth, and structural change, Routledge, New Zealand. Papandreou, G., 1998, Paternalistic capitalism, U of Minnesota Press, Toronto. Tucker, B., 2004, Market structures; Monopolistic competition and oligopoly, Economic for Today, South-Western College Publishing, New York. Read More