Oligopoly as the Ideal Market Structure - Essay Example

Oligopoly is the ideal market structure because it allows society to benefit from the efficiency gains of both competition and monopoly [The ofthe writer appears here] [The name of institution appears here] Outside the admittedly important field of statutory organizations, instances of pure monopoly (sole buyer or seller of a product or service without close substitutes) are rare, particularly in the provision of trading services. A more prevalent form of market situation is one in which there is a small number of buyers or sellers, each of whom handles a large share of the total supply and therefore has certain attributes of monopoly and monopoly power. Such a situation of economic concentration is often referred to as oligopoly. The most important point of similarity is that the oligopolist, as well as the true monopolist, necessarily influences price (i.e. to some extent makes the market) within certain limits. The range within which each oligopolist can independently influence prices is, however, narrower than where there is a pure monopoly, for he has to take into account not only the availability of substitutes (as does a pure monopolist as well), but also the likely actions of his principal competitors in his own market. In all circumstances price changes are likely to affect adversely the interests of certain participants in the market. Increases in price naturally are harmful to consumers, while decreases injure the interests of producers and of some traders. In monopoly and oligopoly situations the power of firms to influence prices, coupled with a high degree of dependence on these firms, tends to provoke allegations that all price changes are deliberately engineered to injure certain interests. Consumers, producers or rival traders may consider that they have been specially and deliberately injured by the actions of the monopolist or oligopolists, and may ascribe market changes to their intentional activities. Plausibility is lent to these views because in these situations the firms can undoubtedly influence the market; indeed, they cannot help doing so. It is therefore impossible conclusively or convincingly to refute allegations of profiteering, of destructive underselling to eliminate particular competitors, of deliberate depression of producer prices, or of wasteful inflation of costs. 1 An important and distinctive characteristic of oligopoly is the realization by each firm that its fortunes depend very closely upon the actions of the others in the same market. Their behaviour is necessarily influenced by the realization of mutual interdependence. Each firm appreciates that in initiating price changes it must expect the other firms to react to these changes, and that in assessing the net effects of a price change it must take account of the probable reaction of others. In deciding on price changes each firm considers not only the general market situation and its own financial and stock position, but also the probable conduct of its principal competitors. Firms recognizing their mutual interdependence may find it convenient and profitable to co-ordinate their policies and to act together, and co-operation is made easier because the numbers are comparatively small. An oligopolistic situation is frequently accompanied by market sharing arrangements between a number of producers or firms. This is particularly likely in the supply of standardized products or services, where these price-fixing agreements may be effective and stable even without formal market-sharing arrangements; banking and shipping provide familiar examples in the United States, in Britain and in Western Europe. Where the product is largely unstandardized, agreements are less often concluded, and, moreover, tend to be unstable; the motor industry seems to be a convenient example. Co-operation is, however, by no means the inevitable outcome of oligopoly. Individual firms may decide to try their strength and to enlarge their share in the market by active competition. Moreover, when new entry is possible, or when some firms do not participate in group activity, the cohesion within the co-operating group tends to be weakened, as differences are likely to arise over the appropriate price and marketing policy to be pursued in the light of the actual or potential outside competition. There are likely to be recurrent phases of intense competition alternating with formal or informal market-sharing arrangements. As each contestant is as much preoccupied with the actual or prospective position and conduct of a few firms as with the general market situation, the competition between the firms is at times likely to assume an almost personal character. The severity and bitterness of the struggle are likely to be enhanced when the risks of trade are considerable, whether as a result of market fluctuations or heavy capital requirements or other factors. 2 The most obvious difference between oligopoly and monopoly is that under oligopoly buyers and sellers are confronted with at least one more firm, possibly several more, so that the dependence upon any one firm is reduced; the reduced dependence is an important advantage to customers which is present to a limited extent even when firms act in concert on major issues of business policy. When the principal firms act together, either informally or in terms of written agreements, the results approximate more or less closely to the results of pure monopoly. The power to influence prices is increased and the number of independent alternatives open to customers is reduced; nevertheless, for reasons already mentioned, the concerted action is unlikely to be as effective as where there is a single monopolist. A measure of peripheral competition, which may take the form either of covert price concessions or of the provision of extra services and benefits, is likely to exist even during the currency of the market sharing arrangements. The mere presence of several firms in independent ownership itself may lessen both the reality and the sense of dependence of customers. However, when the principal firms do not act together, either informally or in terms of formal agreements, the market struggles and manoeuvres tend to differentiate oligopoly sharply from pure monopoly. In the course of such struggles valuable concessions, particularly price concessions, are made to customers. At the same time prices are likely to be unstable and, at times, to show erratic and discontinuous movements. The market warfare may have political consequences affecting the community as a whole, and the government may be drawn into the struggle. Moreover, although customers are likely to receive considerable advantages in the course of the struggle, these may be partly offset by the extra risks of loss in an unstable market situation and their reactions may again have political repercussions. 3 The difference between monopoly and oligopoly may also affect the cost of producing the commodity and providing the service in question. It is not possible on a priori grounds to say whether it will be higher in one case than in the other. For a number of reasons the costs of a monopoly may be inflated. The spur of competition is absent or less keen; and monopoly advantages may be reflected in the form of higher costs rather than of higher profits. Conversely, oligopoly may lead to the underutilization of duplicated facilities. Some of these ostensible duplications may confer genuine advantages on customers; others may be largely redundant. Genuine redundancy is likely to be less important in the provision of trading services in which fixed capital plays a relatively minor part. However, even if average costs are greater under oligopoly than under monopoly, the price of the commodity or service is likely to be more favorable to customers in conditions of oligopoly. 4 In general, oligopoly is an attenuated form of monopoly; compared with the latter it results in reduced dependence on individual firms, less complete control of the market by any one firm, and more favorable prices to buyers and sellers. On the other hand, prices may be subject to more rapid and erratic changes under oligopoly. Both in monopoly and oligopoly situations the firms concerned necessarily have the power to influence market prices, which, however, does not imply that the price can be set at a level which will secure a return to the firms, or remuneration to their management or employees, above the level which could be secured in trades or employment of similar risk and complexity elsewhere. The establishment and continued maintenance of such a price postulates not only a monopoly or oligopoly situation, but also appreciable and lasting obstacles to the entry of new firms. 5 The duration and extent of the power to influence prices, and the likelihood that it will be exercised to secure additional profits and advantages, depend primarily on the nature of the obstacles which impede the provision of additional independent sources of supplies and additional suitable substitutes. The nature of the obstacles also conditions the prospects of remedial government action designed to widen the range of independent alternatives open to buyers and sellers. The obstacles to new entry or to the development of suitable substitutes can be classified in a number of ways, of which two seem of particular relevance, especially from the point of view of public policy. In the first place, the criterion may be the length of time over which the advantages of the power to control the market are likely to persist in the absence of specific government measures designed to remedy the situation. In the second place, the distinction may be made to turn upon whether the obstacle represents largely or wholly some natural scarcity, or whether it is the result primarily of a specific action or attitude of government or of firms in the market. An important subdivision in practice is whether the contrived obstacle is the result of private arrangements or of actions by authority. Unfortunately, it is not generally possible to apply these various criteria unambiguously to the blurred complexities of particular situations. The categories shade into each other and overlap. Frequently the obstacles may be compounded of short-lived or long-lived natural scarcities and of government measures and private arrangements. However, from the point of view of public policy the potentialities of government action are greatest where new entry and the development of substitutes are obstructed partly or largely by contrived barriers, whether resulting from legislation or administrative action or from the private arrangements of the participants in the market. Further, those barriers which derive from government action paradoxically tend to be the most formidable and durable, though they are technically the easiest to rectify if it were thought desirable. The obstacles to entry presented by natural scarcities vary greatly as regards the time required by ordinary market forces to remove them. At one extreme short-lived delays in transport may enable a few favored firms to control a profitable market. The situation will be redressed quickly, a process which will normally be accelerated by the attraction of high profits. At the other extreme the scarcity may reside in an exceptional combination of special experience, knowledge, enterprise, skill and large sums of capital. Here a long period may elapse before the successful combination can be reproduced. Corrective action is clearly unnecessary in situations at the first-mentioned extreme; the early widening of alternatives and limitation on the exercise of monopoly power are provided for in the situation itself. On the other hand, the natural difficulties of reproducing the special combination make corrective action in the sense of widening the area of choice particularly difficult. Such circumstances require that special care is taken to ensure that the results of natural scarcities, which underlie the obstacle, are not aggravated by the contrivance of additional barriers; for example, while a measure of price and profit control may be desirable, it may at the same time delay or discourage efforts to surmount the obstacles. 6 Large accumulations of capital in combination with administrative and technical skill and experience represent a combination of scarce resources which cannot readily be duplicated. Thus where such a combination results in significant economies a large measure of concentration is likely to occur; moreover, new entry will be difficult because of the initial disadvantages of those lacking this scarce combination of resources. Although these advantages which derive from the control of scarce resources are cumulative up to a point, they nevertheless do not often confer permanent powers for securing substantial monopoly profits or abnormally high returns, unless they are reinforced by institutional hindrances to entry, of which administrative measures are the most frequent and effective. This conclusion applies to a wide range of economic activity, but applies with particular force to trading activities. In mining (and conceivably in certain kinds of agriculture) a comparatively small number of producing units may possess all or most of the known supplies of suitable available resources; in manufacturing industry exceptional technical skill or the possession of a particular process may secure substantial long-period exclusive advantages. But it is obviously improbable, not to say impossible, for a trading firm to secure advantages which rest on the possession of a non-reproducible resource or combination of resources. There is thus a strong presumption that quasimonopolistic positions in trading, unless fortified by administrative supports, will in a comparatively short time be assailed by new entrants. Such a development is likely even where the established firms have apparently not used their powers to the full to secure abnormal returns, and it is much more likely to come about when they have done so. Natural scarcities (the combination of special gifts and capital necessary to perform trading services) and private commercial arrangements are not in general likely to provide long-lasting obstacles to new entry into trading activities. Moreover, even where they exist, the monopoly power is likely to be exercised with moderation because the enjoyment of high profits or other advantages is likely to act as an effective spur to the establishment of new firms or the development of new sources of supply. This lends special interest and importance in a study of trade to the presence of barriers resulting deliberately or accidentally from government actions. Effectiveness of an Oligopolistic Market Economy Kinked Demand Curve: The demand or average revenue curve used in this analysis is Kinked. It has a Kink or a knot. The demand curve is not a smooth straight line but has two segments with a varying degree of flexibility or slope. Before we present the Kinked Demand Curve let us begin with its underlying assumptions. Sweezy has made the following two assumptions: i) If the firm reduces its price the producer expects other competitors to introduce a similar price cut; the market demand will increase but the share of the firm will remain unaltered. ii) If the firm raises the price then other competing firms will not follow the price rise. There will be a very small rise in demand but a significant reduction in the sales of the firm. http://www.pinkmonkey.com/studyguides/subjects/eco/chap12/e1212103.asp The two assumptions suggest that neither a fall nor a rise in price would benefit the firm. Oligopoly price is rigidly fixed. Moreover, such a price rigidity causes a Kink in the demand curve with its lower segment steeper or inelastic and its upper segment flatter and more flexible. Consequently there is no incentive to alter price under oligopoly. This will be clearer when explained with the help of a figure. In Figure 44, there are two demand curves, DED, which is flatter and more flexible and D1ED1, which is steeper and less flexible. The two demand curves interest at point E which itself is a point of Kink. The upper portion of the flatter demand curve DE and the lower portion of the steeper demand curve ED1 together make up the Kinked Demand Curve. Under the above stated assumptions the lower portion of the flatter demand curve ED and the upper portion of the steeper demand curve D1E are not operative. Taking into account only relevant segments of the two demand curves a Kinked demand curve DED1 has been formed and presented in Figure 45. Once we locate the point of Kink there is no further problem in oligopoly analysis. The point of Kink, E, is itself an equilibrium point. At such a point equilibrium output produced is Q and price charged is P. http://www.pinkmonkey.com/studyguides/subjects/eco/chap12/e1212103.asp Oligopoly Equilibrium: Once a Kink in the demand curve is known and given, oligopoly equilibrium automatically follows. The point of Kink such as E is itself an equilibrium point. Moreover, such an equilibrium is rigid and stable. There is no incentive on the part of the oligopolist to move away from the point of Kink. Any attempt on his part either to lower or raise the price will not be to his advantage. This can be explained with the help of Figure 46. The lower segment ED1 of the demand curve is steeper. Even with a significant fall in price from P to P1 increase in the quantity demanded QQ1 is very small. Reduction in price will then result in a smaller total revenue for the firm. On the other hand, any attempt to cause a small rise in price as PP2 on the flatter portion ED of the demand curve causes a significant fall in the quantity demanded from Q to Q2. This again will cause total revenue of the oligopolist to be smaller at higher price. The oligopolist is rigidly fixed at E, the point of Kink with P as the price. This therefore is also called sticky price solution. http://www.pinkmonkey.com/studyguides/subjects/eco/chap12/e1212103.asp Oligopoly analysis (such as the above) has been carried out exclusively in terms of demand or average revenue curve. So long as oligopolists find the average revenue higher than the average cost of producing equilibrium output, they will make profits. Any reference to the marginal cost of a firm is not necessary in such an analysis. Therefore it is also called Full Cost (not marginal cost) Oligopoly Equilibrium Solution. Even if we desire to bring in the marginal revenue and the marginal cost curves into the discussion that does not alter the equilibrium attainment of the firm. This can be seen in Figure 47. We have two marginal revenue curves MR and MR1 corresponding to the average revenue curve segments DE and ED1 respectively. The two marginal revenue curves are broken and the broken portion is along the vertical line EQ. Marginal cost curve of the firm passes from the broken portion of the marginal revenue curve. The equality between MR=MC is also fulfilled for the same output level Q and price P. The Kinked demand curve appears to be satisfactory in every respect. http://www.pinkmonkey.com/studyguides/subjects/eco/chap12/e1212103.asp Reference: 1. Competition among the Few: Oligopoly and Similar Market Structures Book by William Fellner; Alfred A. Knopf, 1949 2. Theory of Markets Book by Tun Thin; Harvard University Press, 1960 3. Mixed Oligopoly, Privatization, and Strategic Trade Policy Journal article by Debashis Pal, Mark White; Southern Economic Journal, Vol. 65, 1998 4. The Antitrust Laws of the United States of America: A Study of Competition Enforced by Law Book by A. D. Neale; Cambridge University Press, 1966 5. Paul M. Sweezy Magazine article by Michael A. Lebowitz; Monthly Review, Vol. 56, October 2004 6. Microeconomics and the Space Economy: The Effectiveness of an Oligopolistic Market Economy Book by M. L. Greenhut; Scott, Foresman, 1963 7. http://www.pinkmonkey.com/studyguides/subjects/eco/chap12/e1212103.asp Read More