Oligopolistic Competition

An oligopoly is a market structure in which a few firms dominate. When a market is shared between a few firms, it is said to be highly concentrated. Although only a few firms dominate, it is possible that many small firms may also operate in the market. Considering the market for air travel,  major airlines like British Airways (BA) and Air France often operate their routes with only a few close competitors, but there are also many small airlines catering for the holidaymaker or offering specialist services.

Characteristics of Oligopoly

Now that the Oligopoly definition is clear, it’s time to look at the characteristics of Oligopoly:

1. Few firms

Under Oligopoly, there are a few large firms although the exact number of firms is undefined. Also, there is severe competition since each firm produces a significant portion of the total output.

2. Barriers to Entry

Under Oligopoly, a firm can earn super-normal profits in the long run as there are barriers to entry like patents, licenses, control over crucial raw materials, etc. These barriers prevent the entry of new firms into the industry.

3. Non-Price Competition

Firms try to avoid price competition due to the fear of price wars in Oligopoly and hence depend on non-price methods like advertising, after sales services, warranties, etc. This ensures that firms can influence demand and build brand recognition.

4. Interdependence

Under Oligopoly, since a few firms hold a significant share in the total output of the industry, each firm is affected by the price and output decisions of rival firms. Therefore, there is a lot of interdependence among firms in an oligopoly. Hence, a firm takes into account the action and reaction of its competing firms while determining its price and output levels.

5. Nature of the Product

Under oligopoly, the products of the firms are either homogeneous or differentiated.

6. Selling Costs

Since firms try to avoid price competition and there is a huge interdependence among firms, selling costs are highly important for competing against rival firms for a larger market share.

7. No unique pattern of pricing behavior

Under Oligopoly, firms want to act independently and earn maximum profits on one hand and cooperate with rivals to remove uncertainty on the other hand.

Depending on their motives, situations in real-life can vary making predicting the pattern of pricing behavior among firms impossible. The firms can compete or collude with other firms which can lead to different pricing situations.

8. Indeterminateness of the Demand Curve

Unlike other market structures, under Oligopoly, it is not possible to determine the demand curve of a firm. This is because on one hand, there is a huge interdependence among rivals. And on the other hand there is uncertainty regarding the reaction of the rivals. The rivals can react in different ways when a firm changes its price and that makes the demand curve indeterminate.

Firms behaviour under Oligopoly

Based on the objectives of the firms, the magnitude of barriers to entry and the nature of government regulation, there are different possible outcomes in relation to a firm’s behavior under Oligopoly. These are:

• Stable prices
• Price wars
• Collusion for higher prices

Further, Oligopoly can either be collusive or non-collusive. Collusive oligopoly is a market situation wherein the firms cooperate with each other in determining price or output or both. A non-collusive oligopoly refers to a market situation where the firms compete with each other rather than cooperating.

Non-Collusive Oligopoly-Sweezy’s Kinked Demand Curve Model (Price-Rigidity)

Usually, in Oligopolistic markets, there are many price rigidities. In 1939, Paul Sweezy used an unconventional demand curve the kinked demand curve to explain these rigidities.

Reason for the kink in the demand curve

It is assumed that firms behave in a two-fold manner in reaction to a price change by a rival firm. In simple words, firms follow price cuts by a rival company but not price increases. So, if a seller increases the price of his product, his rivals do not follow the price increase.

Therefore, the market share of the firm reduces significantly as a result of the price rise. On the other hand, if a seller reduces the price of his product, then the rivals also reduce their price to bring it at par with the price reduction of the firm.

This ensures that they prevent their market share from falling. Once the rivals react, the firm lowering the price first cannot gain from the price cut.