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Meaning and Definition:

Oligopoly falls between two extreme market structures, perfect competition and monopoly. Oligopoly occurs when a few firms dominate the market for a good or service. This implies that when there are a small number of competing firms, their marketing decisions exhibit strong mutual interdependence. By mutual interdependence we mean that a firm’s action say of setting the price has a noticeable effect on its rival firms and they are likely to react in the some way. Each firm considers the possible reaction of rivals to its price and product development decisions.

Stigler defined oligopoly:

“As that market situation in which a firm bases its market policy in part on the expected behavior of a few close rival firms”.

Oligopoly, in the words of Jackson:

Oligopoly is an industry structure characterized by a few firms producing all or most of the output of some good that may or may not be differentiated”.

The term ‘a few firms’ covers two to ten firms dominating the entire market for a good. If there are only two firms in the market, the oligopoly is called Duopoly.

Types and Examples:

The analysis of duopoly raises all those problems which are confronted while explaining oligopoly with more than two rival firms. For example, many industries including cement, steel, automobiles, mobile phones, cigrates, beverages etc.; are oligopolistic.

Oligopolies may be homogeneous or differentiated. If firms in an oligopolistic industry produce standardized products like petroleum product, aluminum, rubber products, the industry is said to be producing under oligopolistic conditions.

On the other hand, if the firms are producing goods, which are close substitutes for each other, then differentiate oligopoly is said to prevail. Mutual interdependence is greater when products are identical and it is lesser when goods are differentiated.

Determination of Price and Output (Profit):

There is not a single theory which satisfactorily explains the pricing and output (profit) decisions under oligopoly. The reasons are:

(i) The number of firms, dominating the market vary. Sometimes there are only two or three firms which dominate the entire market (Tight oligopoly). At another time there may be 7 to 10 firms which capture 80% of the market (loose oligopoly).

(ii) The goods produced under oligopoly may or may not be standardized.

(iii) The firms under oligopoly sometime cooperate with each other in the fixing of price and output of goods. At another time, they prefer to act independently.

(iv) There are situations also where barriers to entry are very strong in oligopoly and at another time, they are quite loose.

(v) A firm under oligopoly cannot predict with certainly the reaction of the rival firms, if it increases or decreases the prices and output of its goods. Keeping in view the wide range of diversity of market situations, a number of models have been developed explaining the behavior of the oligopolistic firms.

Causes or Reasons:

The main causes or reasons which give rise to oligopoly are as follows:

(i) Economies of scale: If the productive capacity of a few firms is large and are able to capture a greater percentage of the total available demand for the product in the market, there will then be a small number of firms in an industry. The firms in the industry with heavy investment, using improved technology and reaping economies of scale in production, sales, promotion, etc., will compete and stay in the market. The firms using outdated machinery and old techniques of production will not be able to compete with the low unit costs producing firms and eventually wipe out from the industry. Oligopoly is, thus, promoted due to the economies of scale.

(ii) Barriers to entry: In many oligopolies, the new firms cannot enter the industry as the big firms have ownership of patents or control over the essential raw material used in the production of an output. The heavy expenditure on advertising by the oligopolistic industries may also be a financial barrier for the new firms to enter the industry.

(iii) Merger: If the few firms in the industry smell the danger of entry of new firms, they then immediately merge and formulate a joint policy in the pricing and production of the products. The joint action of a few big firms discourage the entry of new firms into the industry.

(iv) Mutual interdependence: As the number of firms is small in a oligopolistic industry, therefore, they keep a strict watch of the price charged by rival firms in the industry. The firm generally avoid price war and try to create conditions of mutual interdependence.

Characteristics or Features:

The main characteristics or features of oligopoly are as follows:

(i) Small number of firms: Oligopoly is a market structure characterized by a few firms. These handful of firms dominate the industry to set prices.

(ii) Interdependence: All firms in an industry are mostly interdependent. Any action on the part of one firm with respect to output, quality product differentiation can cause a reaction on the part of other firms.

(iii) Realization of profit: Oligopolists firms are often thought to realize economic profits. Whenever there are profits, there is incentive for entry of new firms. The existing firms then try to obstruct entry of new firms into the industry.

(iv) Strategic game: In an oligopolistic market structure, the entrepreneurs of the firms are like generals in a war. They attempt to predict the reactions of rival firms. It is a strategy game which they play.