OLIGOPOLY

The term ‘oligopoly’ has been derived from Greek words,

oligi meaning ‘few’ and polein meaning ‘sellers’ for
example automobiles company, soft drinks companies
like coca cola and Pepsi, and oil companies.
 An oligopoly is a form of market structure characterized
by:-
a) Few firms selling either differentiated or homogeneous
products at the market, “and how few are the sellers” is
not easy to tell or define numerically in the
oligopolistic market structure due to the fact that
economists are not specified about a definite number of
sellers for the market to be oligopolistic in its form; it
may be two, three, four, five or more.
 Characteristics of Oligopoly

In addition to the point, few in their number brings oligopolist

in intensive competition (in the form of non-price
competition, that involves differentiation and advertisement)
with one another; if we carefully observe other market
structures like perfect competition, competition is non-
existent as the number of firms is so large and under
monopoly, there is a single seller and therefore there is
absolutely no competition, under monopolistic competition,
where the number of firms is so large that a degree of
competition is considerably reduced but under oligopoly, the
number of sellers is so small that any move by one seller
immediately affects the rival sellers as result firms keep watch
on the activities of the rival firms and prepare itself with a
number of aggressive and defensive marketing strategies.
 Characteristics of Oligopoly

b)Interdependence of Business Decisions. The nature

and degree of competition among oligopolists make
them interdependent(mutually supporting or
dependent) in respect of decision making. The
reason for interdependence between oligopolists is
that a major policy change in one firm affects the
rivals seriously and immediately, thus it is a source
of action and reaction, moves and counter-moves by
the competing firms.
 Characteristics of Oligopoly

c) Barriers to entry, in along run barriers are strong to

entry of new firms to the industry. If entry is free,
new firms attracted by super-normal profits, if it
exists, enter the industry and the market eventually
becomes competitive. Example of the common
barriers that do exist are economies of scale, price-
cutting, control over important inputs, patent rights
and licensing, absolute cost advantage to old firms,
indeterminate price and existence of excess capacity.
Such factors prevent the entry of new firms and
preserve the oligopoly.
 TYPES OF OLIGOPOLY “KINDS OF OLIGOPOLY
MODELS”

There are two types of oligopoly and that are

─ NON-COLLUSIVE OLIGOPOLY
─ COLLUSIVE OLIGOPOLY
 COLLUSIVE OLIGOPOLY

In collusive oligopoly, firms are assumed to act in unison that is in

collusion (knowledge or approval or agreement) with one another; this
assumption is based on empirical facts, rather than being
conjectural(hypothetical or imaginary).
Or
 Refers to the oligopoly market in which the oligopolistic firms make joint-
pricing and output decisions where by the firms agreed to have a uniform
price-output policy to be pursued by competition among themselves.

WHY COLLUSION?
 It reduces the degree of competition between the firms and help them act
monopolistically in their effort of profit maximization
 It forms a kind of barrier to the entry of new firms.
 It reduces oligopolistic uncertainty surrounding the market since in the
cartel members are not supposed to act independently and in a manner
that is detrimental(harmful or disadvantageous) to the interest of other
firms.
 COLLUSIVE OLIGOPOLY

How ever there are two main types of collusion oligopoly:

─ CARTEL
─ PRICE LEADERSHIP
PRICE LEADERSHIP
A price leadership is informal position of a firm in an oligopolistic
setting to lead other firm in fixing or publishing price of their
product ahead of its competitors who closely follow the prices
already announced; it emerges spontaneously(instinctively or
suddenly) due to technical reasons as size efficiency, economies of
scale and ability of firm to make forecasting concerning market
conditions accurately or out of explicit agreements between the
firms to assign leadership role to one of the them.
N.B
Price leadership is possible under both product homogeneity and
differentiation or heterogeneity.
 PRICE LEADERSHIP

The price readership consist of several types such

as:-
─ Price leadership by a low cost-firm
─ Price leadership by the dominant firm
─ The barometric price leadership
─ The exploitative or aggressive price leadership
 Price leadership by a low cost-firm

It occurs when the low cost firm sets a lower price

than the profit maximizing price of the largest firm
for the small firm to maximize its profit. Thus the
high cost firms will not be able to sell their products
at the highest price hence they are forced to agree to
lower prices to such of the low cost firms.
 Price leadership by a low cost-firm

Consider the figure below The figure shows two firms that face

identical revenue curves i.e. AR =D

and MR but the largest or l0w-cost

P3 H MC2 AC2 firm (L) has its cost i.e. AC1 and MC1,

P2 L MC1 where the small firms have AC 2

AC1 and Mc2. the largest firm has economies

P1 of scale and its cost of production is low

MR AR = D lower than that of other firms,

0 Q1 Q2 hence find it profitable to fix a price at OP2(=Q2H)

and sell at quantity OQ2, and it is at this point where the level of output its MC=MR, hence maximum profit.
 Price leadership by a low cost-firm

On the other hand the high-cost firms (H) would be in

position to maximize profit at price OP3 and quantity
OQ1, however the low-cost firms charge profit
maximizing price OP2, the high-cost firms would lose
their customers to low-cost firms charging low price OP2,
and recognize the price leadership of the largest firm.
Note:
largest firm can eliminate other firms and become a
monopolist, by cutting its price down to OP1 and still
offer the same quantity OQ2 and make , only normal
profit as AC1=OP1, but it may not do so for the fear of
anti-monopoly laws.
 Price leadership by the dominant firm

Happens when a dominant firm shares a large part of the

market along with small firms by producing very large
proportional of total production of the industry therefore
dominate the market product. Hence, the dominant firm
has the great influence over the market for the product as
a result estimate its own demand curve and set the price
which maximizes profit since small firms have no
individual effects on the price of the products, therefore
they follow the dominant firm and accept the price set
and adjust their products as well just like a firm in a
perfectly competitive market, assuming their demand
curve is a straight horizontal line.
 Price leadership by the dominant firm

This is common than the low-cost firm, in its analysis

of price leadership, it is assumed that there exists a
low-cost firms(largest firms) in the industry, which
supply a large portion in the total market and its
dominance is indicated by the fact that it can
possibly eliminate all its rival firms in the market by
price-cutting but later on they gain monopoly which
may create legal problems, hence compromising the
with the existence of the rival firms in the market as
largest firms use their dominance to set profit
maximizing price.
 Price leadership by the dominant firm

The price leadership and market sharing between the

largest firms and the small firms can be illustrated as
follow.
Price cost and price

P3 E P3
P A B P P MCL ACL AR=MR=D

P2 C F P2
P1 P1
DM DL

0 output (small firms) output (dominant firms) QL MRL

 Price leadership by the dominant firm

The above illustration shows the problem confronting

the dominant firms when come to determine price and
output to maximize their profits. Te dominant may
decide to set price at OP = PQL and maximize profit, but
also if the dominant firms set price at OP1 may get loss in
a short run and eliminate small firms as they will fail to
survive
Note
AB stands part of market demand that is unsupplied by
the small firms, hence create market share of the
dominant firms is zero (OP3 = P3E).
The demand for dominant firms (AB or CF)= PB - PA
 Barometric Price Leadership

Is the price leadership where the price leader is the one firm
assumed to be either an old (established in the past) or experienced
or largest (but it is not necessary) or most respected firm which
assesses the changes and have better knowledge of prevailing
market conditions in the most satisfactory way and has ability to
predict the market conditions more precisely than any of its
competitors with regard to the demand for the product, competition
from the related product, cost of production and make changes in
prices which are the best for the view point of all firms in the
industry. Naturally other firms follow it willingly.

Note
Price decisions by a firm having the qualifications of price
leadership is regarded as barometer which reflects the changes in
the business conditions and environment of the industry.
 Barometric Price Leadership

The barometric price leadership evolves for various reasons

include:-
 The rivalry between large firms lead to cut-throat (aggressive
or competitive) competition that gives disadvantages to all
firms but also may make them unacceptable as a leader, thus
firm with a better predictive ability emerges as a price leader.
 Most of firms in the industry may have neither the capacity
nor the desire to make continuous calculations of cost,
demand and supply conditions, hence they find it
advantageous to accept price changes made by a firm which
have been proven able to make reasonably good forecasts.
 Barometric price leadership often develops as a reaction to
long economic warfare in which all the firms are losers.(A. D.
H. Kaplan, Joel B. Dirlam and Robert F. Lanzilotti, 1958)
 4. AGGRESSIVE PRICE LEADERSHIP

It occurs when a very large or dominant firm establishes its

leadership by following aggressive price policies and thus
forces other firms in the industry to follow him in respect of
price. Such a firm will often initiate a more threat to compete
the other firms out of the market if they do not follow him in
setting their prices.
It is also known as exploitative price leadership.
Note
one big firm built its supremacy in the market by following
aggressive price leadership. It compels other firms to follow it
and accept the price fixed by it. In case the other firms show
any independence, this firm threatens them and coerces them
to follow its leadership.
 Difficulties of Price Leadership

Difficulties of Price Leadership: The following are the

challenges faced by a price leader:

(a)It is difficult for a price leader to correctly assess the reactions of

his followers.
(b)The rival firms may secretly charge lower prices when they find
that the leader charged unduly high prices. Such price cutting
devices are rebates, favorable credit terms, money back guarantees,
after delivery free services, easy installment sales, etc.
(c)The rivals may indulge in non-price competition. Such non-
price competition devices are heavy advertisement and sales
promotion.
(d)The high price set by the price leader may also attract new
entrants into the industry and these new entrants may not accept
his leadership.