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An oligopoly arises when a market has a few dominant producers.

An example of an oligopoly is the retail petrol and diesel market – several large companies including Exxon Mobil, Shell and BP control the majority of the market (although fuel outlets linked to supermarkets are gaining market share).

Oligopolies have the following characteristics:

Each of the few producers has a high level of influence – and a high level of knowledge of their competitor strategies.

Their decisions are interdependent. Firms must decide their market strategy to compete with close rivals, but they must also try to anticipate their rivals’ reactions and think what the next step should be in the light of this response.

There are high or substantial barriers to entry.

The products may be differentiated or undifferentiated.

The uncertainty and risks associated with price competition may lead to price rigidity.

In an oligopoly, how do firms compete?
Firms in an oligopoly can compete and behave in a variety of ways, depending on the following factors:

What are the firms' goals, such as profit maximisation or sales maximisation?
The degree of contestability; that is, the entry barriers.
Government control.
Oligopoly can result in a variety of outcomes:

Price stability (e.g., via a kinked demand curve) – firms focus on non-price competition.
Price wars (competitive oligopoly)
Price increases as a result of collusion

Examples of oligopolies
Automobile industry – economies of scale have resulted in mergers, resulting in large multinational corporations dominating the market. Toyota, Hyundai, Ford, General Motors, and Volkswagen are among the largest automobile manufacturers.
Pharmaceutical industry
Coffee shop retail – Starbucks, Costa Coffee, Cafe Nero
Newspapers – The tabloids Daily Mail, The Sun, The Mirror, The Star, and Daily Express dominate the UK market share.
Waterstones, Amazon, and smaller firms such as Blackwells dominate the book retail market in the United Kingdom.

Price wars

Oligopolists are price makers but one of the dangers of using this weapon is that the firm can get drawn into a price war.

An oligopolist would only start a price war if its costs of production were significantly lower than those of its rivals. A price war may be the natural outcome of events, such as overcapacity in the industry or the entry of new firms.

It could also be a defensive tactic where an oligopoly is losing market share to its rivals.

Non-price competition

Although they each have market power in the form of influence over the prices they charge, the uncertainty surrounding the outcome of competitive tactics means that firms may prefer non-price competition.

The firm will therefore be better off concentrating on non-price competition to increase revenue. This may include the following:

marketing competition, including obtaining exclusive outlets such as tied public houses and petrol stations through which breweries and oil companies sell their products

the use of persuasive advertising, product differentiation, brand imaging, packaging, fashion, style and design

quality competition, including the provision of point-of-sale service and after-sale service

In industries where only a few firms operate, the firms have a choice about whether to compete or co-operate.

These two strategies, compete or collude, lead to hugely different outcomes for both producers and consumers:

For producers, collusion is better than competition because it leads to profits that last as long as the firms keep colluding.

For consumers, collusion is worse than competition because it leads to higher prices and lower output.

Collusion is an anti-competitive action by producers.

Informal or tacit collusion is not illegal and usually takes the form of price leadership, where firms automatically follow the lead of one of the group.

The objective is to maximise the profits of the whole group by acting as a single monopolist. The price leader is invariably the dominant firm and has sufficient market power to determine a price change that other firms follow. On the other hand, a cartel is a formal price or output agreement between firms in an industry to restrict competition. This is illegal.

The difficulty in studying oligopoly is that the behaviour of firms can follow two different routes –

in some industries, there may be cut-throat competition between aggressive fi rms

while in others, there may well be cooperation or tacit evidence of collusion.

Consequently, just how one firm actually reacts will depend on how it expects competitors to react. A theory that attempts to explain how oligopolists behave is the theory of the kinked demand curve

It is assumed that a firm is producing at price P and output Q.

If the firm increases its price above P, other firms in the market will not follow.

This is because these firms will be able to sell more themselves, attracting customers from the firm that increased its price. So, the fi rm’s demand curve is A-D and its marginal revenue curve is MR. This demand curve is relatively elastic to an increase in price.

If the firm lowers its price, it assumes that other firms in the market will follow this lead so as not to lose market share.

This starts a price war, the result of which is likely to be that all firms lose out. The demand curve below A is inelastic and indicated by A-D. The marginal revenue curve is EF. So, overall the oligopolist’s demand curve appears to be P1AD. Price will be rigid at P since there is no incentive for a firm to increase or decrease the price it charges. If it did, either way, it would lose out. The kinked demand curve is in some respects a useful way to explain the behaviour of oligopolists.

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