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 Hads
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".
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.
The analysis of
duopoly raises all those problems which are
confronted while explaining oligopoly with more than two rival
firms. 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.
Explanation of Price and Output Determination Under Oligopoly:
There is not a single
theory which satisfactorily explains the pricing and output
decisions under duopoly. 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 of Oligopoly:
The main
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 an
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 of Oligopoly:
The main
characteristics 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.
