Oligopoly is a market structure under which only a few suppliers
dominate the market and the entrance of new suppliers is either
constrained or impossible. Usually, the oligopoly market is dominated by
2-10 firms, who have a joint share of the market of 50% or more.
Automobile, steel, air transport are common examples of oligopolies. Or,
in a global sense, we could call oil producer countries oligopolies and
OPEC – a cartel. At least some firms may influence price due to their
important contribution to the total output. Every firm in the situation
of oligopoly knows that if it, or its competitors either change prices
or output, the revenues of all the participants on the market will
change. That means that firms are interdependent. For example, if
General Morors Corporation decides to raise prices on its cars, it
should consider retaliative moves by Ford, Chrysler, and other
competitors in order to calculate the ultimate changes in sales.
It is generally assumed that every firm on the market realizes
that its changes in prices or output will cause other firms to
retaliate. The kind of retaliation any supplier expects from its
competitors as a reaction to his changes in prices, output, or change of
marketing strategy is the main factor that influences its decisions.
That expected reaction also influences the balance of oligopoly markets.
Oligopolies may interact in two main ways:
Price wars, when a firm tries to increase it sales by reducing prices,
expecting that other firms will not be able to respond by doing the
same. This stops when no firm can low its prices anymore, which occurs
when P=AC and profit equals 0. Unfortunately for consumers, price wars
do not usually last long. Firms have temptations to co-operate with each
other in order to set up higher prices and to share markets in such a
way, as to avoid new price wars and their bad impact on revenues.
From the above factor results co-operation. Its closest form is a
cartel, when a union of oligopolies acts as a monopoly. Cartels are
illegal in many countries of the World.
Another reason for co-operation is to increase the entrance barriers to
prevent other firms (especially the so-called hit and run firms) to join
the market and drop prices. In that situation firms try to coordinate
To answer this question, I first need to describe the way agreement
between oligopolies form. Let us suppose that there are 15 suppliers in
the area A who want to co-operate with each other. These firms set their
prices equal to their average costs. Each of the firms is afraid to
raise prices for the reason its competitors might not follow that move
and its profits will become negative. Let us suppose that the production
is at the competitive level Qc (pic. A), that corresponds to the
production quantity under which the demand curve crosses MC, which is a
horizontal sum of the marginal cost curves of each supplier. MC would
coincide with the demand curve if the market were perfectly competitive.
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