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Oligopoly

In: Business and Management

Submitted By nieyachia
Words 2540
Pages 11
This paper will focus on the behaviour of oligopolists and the situations they are confronted with in their daily business.

The paper is divided in three parts. The first part explains the basic keywords. The second part tries to explain the nice and the sad sides of an oligopolist, and will discuss the consequences of their behaviour.

As well, I will try to examine the statement "being an oligopolist is not easy", and whether it is true or whether the truth lies in between.

Aspects of Market Structure

The four types of market structure are listed in the drawing below:

Characteristics of an oligopoly

Definition

Oligopoly is a type of imperfect competition with a market structure, that has only a small group of sellers which offers similar or even identical products.

Oligopolist, Oligopoly

An oligopoly is a market form in which a market is dominated by a small number of sellers (oligopolists). There are few participants in this type of market and each oligopolist is aware of the actions of the others. Oligopolistic markets are characterised by interactivity. The decisions of one firm influence and are influenced by the decisions of other firms.

The question is how we can describe the market situation of an Oligopolist. If we compare it to the other possibilities of a market situation such as a competitive market or a monopolistic market, it is neither of them.

The typical characteristics of an oligopoly is that each of the market players offer a product similar or identical to the others in a competitive market. This fact distinguishes the market structure from a monopolistic competition where the firms are similar but not identical.

On the other side, there exists more than one player in this kind of market what makes it different from the monopoly. So the situation begins in a difficult way for an oligopolist: on the one side he would like to play the game of a monopolist and on the other side, he does everything to avoid the entry of new players, which will have a negative impact about his profit. So, he is faced with the first dilemma. We will go deeper into this topic later in the paper.

An oligopoly market is a market form, which is something between these two kind of extreme market situations. Companies in these markets have competition but at the same time are not faced with too much competition so that they are price takers.

Now we understand how economists define the various types of market structures, so we can continue our analysis.

Oligopoly is best defined by the conduct (or behaviour) of firms within a market rather than by its market structure.

Oligopolistic firms are very large, with high market concentrations. Oligopoly is the dominant mode of organisation in many sectors of the economy. This concentration can be measured by looking at the market share of each company. Table 1.1 shows that the market for vehicle testing is highly concentrated within 4 firms supplying almost 97% of the whole market.

Market Share Overview Dekra:

DEKRA TÜV GTÜ KÜS FSP VÜK TFÜ GTS
Germany 00 GJ (22 Mio.) 35,65% 46,58% 9,37% 5,20% 1,69% 0,51% 0,87% 0,14%
Germany 01 GJ (23,6 Mio.) 35,76% 45,11% 10,02% 5,86% 1,69% 0,52% 0,87% 0,17%
Germany 02 GJ (23,6 Mio.) 35,68% 44,26% 10,61% 6,46% 1,68% 0,49% 0,61% 0,21%
Germany 03 GJ (24,4 Mio.) 35,46% 43,27% 11,24% 6,93% 1,81% 0,44% 0,62% 0,24%
Germany 04 GJ (24,1 Mio.) 35,19% 42,56% 11,83% 7,28% 1,87% 0,40% 0,63% 0,24%
Germany 04 1 HJ (13,1 Mio.) 35,17% 42,78% 11,70% 7,21% 1,86% 0,41% 0,63% 0,24%
Germany 05 1 HJ (12,9 Mio.) 35,02% 41,84% 12,32% 7,66% 1,89% 0,38% 0,65% 0,24%
Germany Delta 04/05 in % -0,15% -0,94% 0,62% 0,45% 0,03% -0,03% 0,02% 0,00%

Concentration ratio

In economics, the concentration ratio of an industry is used as an indicator of the relative size of firms in relation to the industry as a whole. This may also assist in determining the market form of the industry. One commonly used concentration ratio is the four-firm concentration ratio, which consists of the market share, as a percentage, of the four largest firms in the industry.

An oligopoly is a form of economy. Using the four-firm concentration ration, an oligopoly is defined as a market in which the four-firm concentration ratio is above 40% according to Wikipedia.

In more general terms, a way of measuring market share is to look at the concentration ratio (CRN): The N-firm concentration ratio is the percentage of market output generated by the N largest firms in the industry. We already covered the most used- CR4 - percentage of sales of the 4 top firms in the industry.

One measure of this ratio is the 5 firms concentration ratio which shows the market share of the 5 largest companies.

Normally an oligopoly exists when the top five firms in the market account for more than 60% of total market demand/sales. Relating to the index featured above, the market share for standard and emissions´ test remained approximately at over
98,76 % for the 5 top market players ( Dekra, TÜV, GTÜ, KÜS, FSP), so the company in which I work is an oligopolist.

Oligopolical games as a Prisoners' Dilemma

For understanding the function of oligopoly games, we need to define the game of prisoners´ dilemma. It is a game between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial.
The oligopoly game is based on the prisoners´ dilemma. It turns out that the game oligopolists play in trying to reach the monopoly outcome is similar to the prisoners` dilemma. In this constellation we have two countries, called Iraq and Iran. Both sell crude oil. The figure shows how the profits of the two countries depend on the strategies they choose.
In the game theory, a dominant strategy is a strategy that is best for a player in a game regardless of the strategies chosen by the other players. So in this case a dominant strategy for Iraq is to produce oil on high level, because regardless what Iran chooses to do, Iraq earns more profit on high production than with low production.

Imperfect Competition

There are still a large number of sellers in an imperfectly competitive market.
However, the products are heterogeneous rather than homogeneous. In other words, products are differentiated from each other by branding. Advertising is a major feature of imperfect competition. Advertising is the most important feature of non price competition.

Although firms have some power to set prices this is limited by the downward sloping demand curve. The firms are seeking to create a brand image for what is in reality a homogeneous product.

For example, standard test and emissions test for vehicle are homogeneous service but we try to convince the customer our service is better than the service from our competitors . We do that with marketing activity, trying to draw a picture which is different from the competitor from the point of view of our customers.
An example is the "Schumacher DEKRA Cap": at the beginning of his career , DEKRA sponsored him and he had to wear a Dekra cap which raised dramatically our brand image. If we don't do this kind of activities, we are afraid of losing market share to our rivals but we also know that all these activities have negative impact on our profit.

To understand why Dekra´s life as an oligopolist is not so easy, we have to discuss the typical behaviour of an oligopolist.

Oligopolistic Behaviour

Strategic planning of oligopolists always involves taking into account the likely responses of the other market participants.

Game theory is as a good tool for illustrating possible consequences of interdependence for the behaviour of firms in oligopolistic markets. Some of the most known models are:

- Stackelberg's duopoly: In this model the firms move sequentially
- Cournot's duopoly: In this model the firms simultaneously choose quantities
-Bertrand's oligopoly: In this model the firms simultaneously choose prices
-Monopolistic competition: In this model firms pay fixed costs to enter the market.
- Contestable markets by Baumol.

Oligopolistic markets are protected in similar ways as monopolies but not to the same extent. There are barriers to entry, some are legal barriers like the ones enjoyed by the Post on letters; others are ownership barriers like those enjoyed by Bsky B because of its ownership of the satellite. Others have built barriers with their size - for example a company has to be very big to be in the oil business - essentially a technical barrier.

There are also artificial barriers to entry, defensive strategies designed to keep out interlopers; some of these are for example:

1. Product branding: Each firm in the market is selling a branded (differentiated) product
– Heavy advertising within an industry imposes heavy entry costs on new business
– Brand proliferation means that new entrants can only hope to pick up a small percentage of brand shifters. ( An example is the cigarette industry where 3 firms have 91% of the market but where there are over 15 brands)

– My Company behaves the same: we use our marketing instruments and lobby work to keep regulations high in order to avoid rivals´ entry in our market. But these activities cost a lot of money and we can't easily raise the prices for our services. I try to explain in the next paragraph why it is so difficult to do so.

2. Entry barriers: Significant entry barriers into the market prevent the dilution of competition in the long run which maintains supernormal profits for the dominant firms. It is perfectly possible for many smaller firms to operate on the periphery of an oligopolistic market, but none of them is large enough to have any significant effect on market prices and output.

In other situations, competition between sellers in an oligopoly can be fierce, with relatively low prices and high production. This could lead to an efficient outcome approaching perfect competition.

Pricing Strategies under Oligopoly

In an oligopoly, firms operate under imperfect competition, the demand curve is kinked to reflect inelasticity below market price and elasticity above market price, the product or service firms offer are differentiated and barriers to entry are strong.

If a price war breaks out, oligopolists will produce and price much as a perfectly competitive industry would; at other times they act like a pure monopoly. But an oligopoly exhibits the following features:

a) Interdependent decision-making
Interdependence means that firms must take into account likely reactions of their rivals to any change in price, output or forms of non-price competition. In perfect competition and monopoly, the producers did not have to consider a rival's response when choosing output and price.

b) Non-price competition
Non-price competition is a consistent feature of the competitive strategies of oligopolistic firms. Examples of non-price competition includes:
- Free deliveries and installation
- Extended warranties for consumers and credit facilities
- Longer opening hours (e.g. supermarkets and petrol stations)
- Branding of products and heavy spending on advertising and marketing
- Extensive after-sales service
- Expanding into new markets and diversification of the product range

In an oligopolistic market with few firms price competition is rare. If one firm cuts prices the others will follow to avoid losing market share. Similarly price rises will not be followed because the firm raising prices risks losing market share.

Firms can try to mimic monopoly conditions by pursuing joint profit maximising behaviour.

Oligopolistic competition can give rise to a wide range of different outcomes. In some situations, the firms may collude to raise prices and restrict production in the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a cartel.

– This means jointly maintaining prices and raising or lowering them in concert.
– Such collusion - known as a cartel - is illegal under competition law.

In these situations, Dekra is in a big dilemma. We are not allowed to speak with each other in the market to target the price-level. And so we observe the strategies of our competitors and react if they move their prices. On the other side, we are never sure when we raise the price, if our competitor does the same. For example in the last price round 2004, 4 weeks after we raised our price in the south of Germany, our competitors didn't follow and we brought the prices back to the old level: this was very frustrating…but a typical behaviour if you compare it to the concept of prisoners` dilemma.

Firms often collude in an attempt to stabilise unstable markets, so as to reduce the risks inherent in these markets for investment and product development. There are legal restrictions on such collusion in most countries. A formal agreement is not necessary for a collusion to take place (although for the act to be illegal there must be a real communication between companies) - for example, in some industries, there may be an acknowledged market leader which informally sets prices to which other producers respond, known as price leadership.

Public policy towards Oligopolies

Restraint of trade and the Antitrust Laws

For many centuries the judges of the United States and in England have deemed agreements among competitors to reduce quantities and raise prices to be contrary to the public good. So they have refused to enforce such agreements.
But the Sherman Antitrust Act of 1890 codified and reinforced this policy.
The act elevated agreements among oligopolists from an unenforceable contract to a criminal conspiracy.
These laws are used to prevent oligopolists from acting together in ways that would make their markets less competitive.

CONCLUSION

Oligopolies would like to act like monopoly systems, but the factor self-interest drives them closer to competition. So, oligopolies can end up looking either more like monopolies or more like competitive markets. Their strategic reaction and behaviour is depending on the number of firms in the oligopoly and how cooperative these firms are. The concept of the prisoners' dilemma shows that the self-interest of oligopolists can prevent them to react corporately to the other firms, even when cooperation is in their best interest.

Oligopolistic firms behave in dependence of the behaviour of their rivals and reactions will differ according to the market situation.

Policymakers use the antitrust laws to regulate the behaviour of oligopolists. In this way, they try to prevent the oligopolies from engaging in behaviour that minimises competition. The scope of these laws is being continuously . Price fixing among competitors reduces economic welfare and should therefore be illegal; still some business practices which apparently reduce competition may have legitimate – even if subtle - purposes.

From my point of view, it is true that being an oligopolist is quite hard… but that's the game and everyone has the choice to enter the game or not !

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...THE IIS UNIVERSITY JAIPUR Indian Airlines- an oligopoly INDEX ACKNOWLEDGEMENT WHAT IS OLIGOPOLY? An oligopoly  is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). Oligopolies can result from various forms of collusion which reduce competition and lead to higher prices for consumers. Oligopoly has its own market structure.[1] With few sellers, each oligopolist is likely to be aware of the actions of the others. According to game theory, the decisions of one firm therefore influence and are influenced by decisions of other firms. Strategic planning by oligopolists needs to take into account the likely responses of the other market participants. The major characteristics of a market proving it to be an oligopoly are:- 1. Profit maximization conditions An oligopoly maximizes profits. 2. Ability to set price Oligopolies are price setters rather than price takers. 3. Entry and exit Barriers to entry are high. The most important barriers are government licenses, economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy nascent firms. Additional sources of barriers to entry often result from government regulation favoring existing firms making it difficult for new firms to enter the market. 4. Number of firms "Few" – a "handful" of sellers.[3] There are so few firms that the actions of one firm can......

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Monopolies and Oligopolies

...Industry A Concentration ratios are used to measure the extent of competition in an industry by looking at the total output produced by the largest firms. Although there are several measures in the literature, generally the biggest four and biggest eight firms are considered (Cabral, 2000). A low concentration ratio is regarded as an industry with more competition and firms have very low control. The low concentration can be from 0 to 50 per cent and the industry can have a structure ranging from perfect competition to oligopoly. Since in industry A there are 20 firms and the CR is 20 per cent, it can be deemed as a low ratio. Therefore, the industry is a perfectly competitive one with a lot of firms competing with each other, and no one firm controls a big chunk of the market. A perfectly competitive industry has many buyers and many sellers, also the products are quite standard and resemble to each other (Microeconomics: The Basics). The number of sellers makes it impossible for any single firm to control the market and the price is determined by the demand and supply conditions. Since the products are very similar or identical to each other, the buyers can switch from one good or service to another when there are price differentials. Additionally, the barriers to entry and exit are quite low; hence firms can easily enter and leave the industry. As a result of all these features, the economic profits are zero and maximum efficiency is achieved. Nevertheless, the pure......

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