Oligopoly

Meaning of Oligopoly

The term ‘Oligopoly’ is developed from two Greek words ‘Oligo’ meaning a few and ‘pollein’ meaning to sell. Oligopoly refers to that situation in which there are a few number of sellers of the same product. It is a form of market organization in which there are a few sellers selling the homogeneous or differentiated product. Oligopoly is a market situation that is controlled by small group of firms.An oligopoly is much like a monopoly, in which only one firm or organization uses control over most of a market. In an oligopoly, there are at least two firms controlling the market. Economists do not specify how few the number of sellers is in an oligopolistic market. However, two sellers are the limiting case of oligopoly. When there are only two sellers, the market is called duopoly. Oligopoly situation can be classified on different bases such as i) basis of product differentiation ii) basis of entry of firms iii) basis of price leadership and iv) basis of agreement.

Characteristics of Oligopoly:

1. Interdependence

Under oligopoly, firms are independent in making a decision. It is because the number of competition is low and any change in price, as well as a product by a firm, will have a straight effect on the chance of its rivals, which in turn strike back by changing their price as well as output. Accordingly, under oligopoly, a firm not only thinks the market demand for its product but also the response of other firms in the industry. No firm can fail to take into account the response of other firms to its price as well as output policies. Therefore, under oligopoly, there is a good deal of interdependencies of the firm.

2. Importance of selling costs

Under oligopoly, the firms employ defensive and aggressive weapons to increase a greater share in the market which will maximize sales of the firm. In view of this firms have to sustain a great deal on advertisement as well as other measures of sale promotion. Thus advertising and selling cost play a great role in the oligopoly market structure. Under perfect competition and monopoly market structure, expenditure on advertisement and other measures is not necessary. But such advertising expenditure is the life blood for the firm under oligopoly.

3. Indeterminateness of demand curve 

This feature is the direct result of the interdependence feature of the firm under oligopoly. Mutual interdependence makes uncertainty for each and every firm. No firm can forecast the result of its price-output policy. Under oligopoly, a firm cannot presume that its rivals will keep their price constant if he creates change in its own price. As a result, the demand curve facing a firm under oligopoly losses its determinateness. The demand curve as is well known relates to the various quantities of the product that could be sold in different levels of prices. When the quantity to be sold is itself unknown and uncertain, the demand curve can't be definite and determinate.

4. Price rigidity

Under oligopoly, there is the subsistence price rigidity. Prices tend to be rigid as well as sticky. If one firm makes a price cut, it immediately strikes back by the rival firms by the same policy of price cut. There occurs a price war between firms in the oligopoly market condition. Therefore under oligopoly, no firm makes price cut without making price and output decision with other rival firms. The net result will be price -finite or price rigidity in the oligopoly market condition.

5. Barriers to Entry 

Barriers to entry to an oligopolistic industry arise due to the following market conditions:
i) Huge investment required matching the production capacity of existing ones.
ii) Economies of scale and absolute cost advantage enjoyed by existing firms
iii) Strong consumer loyalty to the products of the established firms based on their quality and service
iv) Resistance by the established firms by price cutting.

6. Small number of sellers 

The important feature of oligopoly situation is that the number of sellers dealing in a homogeneous or differentiated product is very small. It means that the pricing and output policy of an individual seller in the market can influence the industry price and output. Each firm controls a large share of the markets and therefore, it is able to make a noticeable effect on the market activities by changing his output.

7. Excessive Expenditure on Advertisement 

It is known that the firms under oligopoly produce close substitutes and they are interdependent. Each firm has to stick to its prevailing price. Now the only way to increase the sales is the advertisement and the improvement or variation in the design and quality of the product. Each firm spends a lot on the advertisement. It plays an important role in determining the demand function of the firm’s product.

Thus the primary purpose of advertising is to shift the demand curve to the right faced by the firm, and also to make it less elastic. This will enable the firm to sell a larger volume of output at the same price or probably at a higher price without the risk of price-war. Each firm tries to encroach upon the markets of others through advertising instead of price-cutting.

Under oligopoly, the products of various firms can be differentiated effectively. It is done only by advertising. Each firm tries to attract consumers to its particular brand name by advertising; although basically, the product of each firm may be the same as that of other firms in the industry. Variations in quality and design of particular products are usually used along with advertising to differentiate the product of one firm from another. The objective of quality variation is the same as that of advertising. The primary objective is to shift the demand curve to the right and make it less elastic.

8. Group behavior 

Another important feature of oligopoly is the analysis of group behavior. In the case of perfect competition, monopoly and monopolistic competition, the business firms are assumed to behave in such a way as to maximize their profits. The profit-maximizing behavior on his part may not be valid. The firms under oligopoly are interdependent as they are in a group.

9. Elements of monopoly 

There exist some elements of monopoly under the oligopolistic situation. Under oligopoly with product differentiation, each firm controls a large part of the market by producing a differentiated product. In such a case, it acts in its sphere as a monopolist in lining price and output.

Reference

Koutosoyianis, A (1979), Modern Microeconomics, London Macmillan