NATIONAL LAW SCHOOL OF INDIA UNIVERSITY NAGARBHAVI, BANGALORE

Product choice and Oligopoly Market Structure

Course Teacher: Prof. (Dr.) N.L. Mitra (Competition Policy and the Law) For the Academic Year 2011-2012

SUBMITTED BY:Jamshed Ansari LL.M., II YEAR, IV TRIMESTER Student Id. No. 419

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Acknowledgment

I express my sincere gratitude to Prof. (Dr.) N.L. Mitra and owe my foremost regards to him for giving me an opportunity to carry out this project work under his valuable guidance. This work would not have been possible without his irreplaceable support and thought provoking comments. It is due to his patient guidance that I have been able to complete this research project. I am very pleased to present this research project on “Product choice and Oligopoly Market Structure”. This is a sincere effort by me.

However I have tried out best, at the same time I know that there is nothing called perfection so I would like to have all valuable suggestion by Respected Sir for future.

With profound gratitude Jamshed Ansari (Business Laws) LL.M., II Year, IV Trimester, Student Id. No. 419

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CONTENTS

 Abstract ……………………………………………………………..………………………………………..…..4 1 2 3 4 5 6 Scope and objective of study ……………………………………………………………….…..4 Research methodology ……………………………………………………………………….…..4 Hypotheses …………………………………………………………………………………………….4 Research question……………………………………………………………………………….….4 Limitation ………………………………………………………………………………………......….4 Mode of citation ………………………………………………………………………..…………….4

 Introduction……………………………………………………………………………………………..………5  Chapterisation.……………………………………………………………………………………………5-10

 Conclusion…………………………………………………………………………………………………..10-11

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ABSTRACT
1. Scope and Objective of Study The object of the write-up is to examine the oligopoly form of market and the product choice in such a market. Further it examines the oligopoly market structure implication of endogenous product choice by firms. 2. Research Methodology The writer has adopted the descriptive, comparative, analytical methods as a research methodology throughout the course of this paper and he is relying on books, articles and online databases. 3. Research Questions The writer has formulated the following questions and has tried to find out the answerWhat derives the product type decisions of firms in oligopoly markets? 4. Limitation The writ- up is limited to examine the oligopoly market structure implication of endogenous product choice by firms. 5. Mode of citation The writer has followed the uniform model of citation throughout the write up.

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Product choice and Oligopoly Market Structure Intruduction:
For the purpose of understanding the causes and consequences concentrated industry structure continues to pose a formidable challenge for industrial organization economist. The markets in which firms can differentiate their products are especially complex, as every firm‟s product choice affects its own benifitability and the extent of product differentiation influences the intensity of competition for all market players. The author in this paper likes to solve one very important question i.e. What derives the product type decisions of firms in oligopoly markets? Further this paper analyzes the structure of differentiated product market by estimating equilibrium model that predicts the number of firms operating in the market and the product types each firm has chosen1.

Market:
The word market means where goods are bought and sold. In Economics, “market is the process by which buyers and sellers of goods interact to determine its price and quantity”. Markets however, vary in their physical and legal arrangements and in their established procedure for buying and selling. Normally market consists of buyers and sellers; sometimes brokers, agents, speculators also play a part in the market mechanism. Market plays an important role in a capitalist or mixed economy.

Classification of Markets:
Markets can be classified according to a) Location, b) Time element, and c) Situation.

1

Michael J. Mazzeo, Product choice and oligopoly market structure, the Rand Journal of Economics, vol. 33, no. 2, summer 2002, pp. 221-242.

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The following diagram2 classifies the markets as follow:

Markets

Location /demand and supply

Time

Situation

Perfect Local National International very short period short period long period Very long period Perfect competition market:

Imperfect monopoly duopoly oligopoly

Perfect completion is a market structure where there is a perfect degree of competition and single price prevails. The concept of perfect completion was introduced by Dr. Alfred Marshal. Nothing is 100% perfect in this world and therefore this stage of perfect completion is only a theoretical possibility and it does not exist in reality. In the perfect market structure there is a large number of buyers and a large number of sellers. The quantity of goods bought by any individual transactor is so small relative to the total quantity traded that individual trades leave the market unaffected. The units of goods sold by different sellers are the same - the product is

homogeneous in such a market. There is perfect information to all the buyers and sellers and they have complete information on the prices being asked and offered in other parts of the market and there is perfect freedom of entry to and exit from the market. In this type of market neither buyer nor seller can influence the market. Both buyer and seller are price giver and price taker. Example of perfectly competitive markets is agricultural products, commodities such as corn and wheat.

2

Prof. K.C. Gopalakrishnan, Legal Economics, Eastern Book Company, Lucknow, 1998, p. 48.

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Imperfect competition market: In the world imperfect competition is widely prevalent. The concept of imperfect competition was developed by an English economist John Robinson (1903-1983). Imperfect competition is a seller‟s market. It is types of competition where firms selling goods and services have market power and can largely affect their selling price. There are numeral forms of imperfect competition such as, a) Monopoly- one firm industry b) Monopsony - single buyer but many sellers c) Duopoly- two sellers d) Oligopoly- few sellers e) Oligopsony – number of buyers are small

Oligopoly market structure:
Oligopoly is the term derived from two Greek words „oligos‟ meaning a few and „pollein‟ meaning to sell. Thus oligopoly refers to that form of imperfect competition where there will be only a few sellers producing either a homogeneous products which are close substitutes but not perfect substitutes. Oligopoly is also referred to as “competition among the few” as the few big firms will be producing and competing in the market3. This is a market structure where there is competition among few firms. Only a small number of firms are to produce and compete in the market. Prof. Stigler defines oligopoly as “that situation in which a firm bases its market policy in part on the expected behavior of a few close rivals”. Lipsey defines oligopoly form of the market in the following words, “oligopoly is the theory of imperfect completion among the few; it refers to an industry that contains only a few competing firms. Each firm has enough market power to prevents its being a price taker; but each firm is

3

Dr. S. Sankaran, Micro Economics, Shree Karthikeyan Publication, 1987, p. 531.

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subject to enough inter firm rivalry to prevent it considering the market demand curve as its own”. The best examples of oligopoly are markets for tea and petroleum where a big firm will be competing in the market of the country.

Characteristics of oligopoly:
The following are main characteristics of oligopoly: 1) Few sellers and many buyers: In oligopoly form of market structure only few firms dominate the industry. For example, four companies Tata, Maruti, Hyundai and Cielo produce lump sum 90% of small cars. In this type of market the firms can influence the price and output by their action. 2) Homogeneous or differentiated products: In this market the firms produce either homogeneous or differentiated products. If they produce homogeneous product i.e. steel or cement the industry is known as pure or perfect oligopoly market. 3) Mutual independence: One of the very important characteristics is mutual independence. It means that the firms are mostly affected by each other‟s price and output decision. For example if one firm lowers the price of his product its own sales will increase but other firm‟s sale will decrease. 4) Lack of uniformity: In oligopoly form of market the size of firms are not uniform. Some firms may be much large but some may be so small. For example, in small car segment of automobile industry the share of maruti is 86% but share of snatro or tata is much less4. 5) Advertisement: In oligopoly form of market the firms has to spend much expenditure on advertisement. There is high cross elasticity of demand for production and price rigidity. The only way open to the firm under oligopoly market to increase his sales by making advertisement to their product.
4

TR Jain, Principle of Micro Economics

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6) Element of monopoly: In oligopoly form of market we can see to the some extent the element of monopoly. It is because every firm has monopoly of its own brand and hence no other firm can sell his product under that brand. However, the firms can raise the price and earn the monopoly profit through collusion. 7) Existence of price rigidity: In oligopoly form of market we see the price rigidity. It means that the firms are interdependence to each other and hence increasing or decreasing the price of product by one will obiously affect the others. For example if a firm tries to raise its price, the other firms will not do so and as a result the firm would incur loss and lose the customers. 8) Keen competition: There is keen competition among rivals. This is because the number of sellers is so small that any move by one firm will immediately affect the rival firms. That is why each firm keeps a close look at the activities of other rival firms and prepare itself to counter it. 9) Uncertainty: The uncertainty prevails in oligopoly form of market. Due to interdependence of players to each other in the market, no certain prediction can be made. On the basis of existing facts and circumstances, it is difficult to calculate the current economic changes. 10) Existence of non-profit motive: In this type of market the firms may not always aim to maximize the profit. They may have other motives such as sales maximization, out put maximization, risk minimization security maximization etc. 11) Some barriers to entry: Some barriers to entry is found in the oligopoly form of market. Some common entry barriers are economies of scale, patent rights control over inputs, preventing price and prevailing excess capacity etc.

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Classification of oligopoly:
There are different types of oligopoly depending on the relationship of the few firms producing the commodity. These are as follow: 1) Pure and differentiated oligopoly 2) Open and closed oligopoly 3) Collusive and competitive oligopoly 4) Partial and full oligopoly 5) Syndicated and organized oligopoly

Endogenous product choice:
The two related mechanism determine equilibrium market structure in a differentiated product oligopoly: 1) Each firm‟s entry and product type decision, and 2) How these choices affect the other firms in the market. Firms make their product choice by comparing payoffs to operating under each product type alternative5. Meanwhile, the number of competing firms and their product types will affect the toughness of price competition and the payoffs for firms under each possible product choice. Since every firm‟s behavior affect the product choice of all its competitors, the entry and product type decisions of all market players should be estimated simultaneously.

Conclusion:
This paper examines the oligopoly market structure implications of endogenous product choice by firms. An appropriate model of oligopoly market structure must estimate simultaneously the decision of all market players. Previous analyses of product differentiated markets did not incorporate the fact that the product type chosen by players affect all firms‟ payoff and thus their product choices. The author found three main conclusions from the estimated parameters of the endogenous product choice equilibrium models. These are as follow:

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Ibid 1

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1. The evidence from oligopoly markets strongly supports the product choice theory that predicts firms will offer products unlike those of their competitors. Negative effect that a competitor has on firm payoff is up to twice as large if that competitor is the same product type. 2. The result demonstrates that demographic variables representing the influence of demand factors help predict both how many firms can operate profitably in the market and the firms‟ product type decision. The effect of demand characteristics can be large enough in some cases to outweigh relative difference in the competitive effects, resulting in an undifferentiated market configuration. 3. Varying the degree of commitment that firms make to entry and product choice has minimal effect- the Stakelberg and two substage versions of the model predict extremely similar values for both competitive and demand effects on payoffs and equilibrium product type configuration outcomes. Whereas theory models demonstrate that there are scenarios under which different assumptions about entry and product choice commitment can lead to alternative equilibrium market structure predictions in some cases, the result indicates that the incidence and influence of such scenarios are quite small. In this analysis the effect of game specification were empirically negligible.

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