OLIGOPOL

Y
Chapter 11: Economics IB
Course Companion
Blink & Dorton, 2007, p119-125

The Assumptions of
Oligopoly
Oligopoly is where a few firms dominate an
industry.
The industry may have quiet a few firms or
not many, but the key factor is that a large
proportion of the industrys output is
shared by just a small number of firms.
What constitutes a small number varies, but
a common indicator of concentration in an
industry is known as the concentration ratio.

Concentration Ratios
Concentration ratios are expressed in the
form of CRx where X represents the
number of the largest firms.
For example: CR4 would show the
percentage of market share or output held
by the largest four firms in the industry.
The higher the percentage, the more
concentrated is the market power of the
four largest firm.

Concentration Ratios
While other concentration ratios such
as CR8 are measured, it is the CR4
that is most commonly used to make
a link to a given market structure.

CONCENTRATION RATIOS AND MARKET

STRUCTURES

Case Study:
US Malt Beverages Industry
In the US malt beverages industry,
there are 160 firms and the CR4 is
90%.
The four largest firms produce 90%
of the industrys output and it is an
industry with a high concentration of
market power among the largest four
companies
The malt industry is clearly example
of an oligopoly.

TASK: Concentration
Ratios
Identify five industries in the United
States or China, that you think would
be considered oligopolies.
What do you think the contraction
ratio would be for each industry?

Case Study:
US Frozen Fish & Seafood Industry
In the frozen fish and seafood
industry, there are 600 firms and the
CR4 is 19% suggested low
concentration.
The frozen fish and seafood industry
is in monopolistic competition.

Type of Oligopolistic
Industries
Oligopolistic Industries may be very
different in nature.
Some produce almost identical
products. (Eg: petrol, where the
product is almost exactly the same
and only the names of the oil
companies are different
Some produce highly differentiated
products: eg motor cars.

Barriers to Entry
In most examples of oligopoly, there
are distinct barriers to entry,
usually the large scale production or
the strong branding of the dominant
firms, but this is not always the case.
In some oligopolies there may be low
barriers to entry.
This explained by contestable market
theory.

Interdependence &
Oligopolies
The key feature that is common in all oligopolies is
that there is interdependence.
Whereas in perfect competition and monopolistic
competition the firms are all too small relative to the
size of the market, to be able to influence the
market, in oligopoly there is small number of large
firms dominating the industry.
As there are just a few firms, each needs to take
careful notice of each others actions.
Interdependence tends to make firms want to
collude and so avoid surprises and unexpected
outcomes.

Oligopolies & Collusion

If oligopolies conclude and act as a
monopoly, then they maximize
industry profits.
However, there may also be
tendency for firms to want to
compete vigorously with each other
in order to gain a greater market
share.

Oligopolies and Price

Issues
Oligopolies tend to be characterised
by price rigidity.
Prices in oligopoly tend to be change
much less than in more competitive
markets.
Even where there are production-cost
changes, oligopolistic firms often
leave their prices unchanged.

COLLUSIVE OLIGOPOLIES
Collusive Oligopoly exists
when the
firms in an oligopolistic
market
collude to charge the same
prices for
their products, in effect
acting as a

Two Types of Collusion

There are two main types of collusion:

Formal Collusion
Tacit Collusion

Formal Collusion
Formal conclusion takes place when firms
openly agree on the price that they will all
charge, although sometimes it may be
agreement on market share or an marketing
cartel. This type of collusion is called cartel.
Since this results in higher prices and less
output for consumers, this is usually deemed to
be against the interests of consumers.
Collusion is generally banned by governments
and is against the law in the majority of
countries

Anti Trust Authorities &

Formal Collusion
If a countrys anti-trust authority
finds that firms have engaged in anticompetitive behaviour such as pricefixing agreements, then the firms will
be penalised with fines or other
punishments.

Formal Collusion &

Cartels
Formal collusion between governments
may be permitted.
The prime example is OPEC
The Organization of Petroleum
Exporting Countries.
OPEC is a cartel.
It sets production quotas, which has a
very significant influence on the price of
oil on world markets.

Tacit Collusion
Tacit collusion exists when a firms in
oligopoly charge the same prices without
any formal collusion.
A firm may charge the same price as
another by looking at the prices of a
dominant firm in the industry, or at the
prices of the main competitors.
It is not necessary for firms to
communicate with each other to charge
the same price.

OLIGOPOLISTS
ACTING AS A
MONOPOLIST

With both
formal and tacit
collusion the
process is the
same. The
firms behave
like a
monopolist
(single
producer)
charge the
monopoly price,

Collusive Oligopoly & Price

Rigidity
Collusive oligopoly offers one
explanation of price rigidity in
oligopoly.
If firms are colluding, either formally
or tacitly, and they are making their
share of long-run monopoly profits,
then they may try to keep prices
stable in order that the situation
continues.

NON COLLUSIVE
OLIGOPOLY
Non-collusive oligopoly exists when
the firms do not collude and so have
to be very aware of the reactions of
other firms when making pricing
decisions.
The behaviour of firms in an
oligopoly is strategic behaviour.
They must develop strategies that
take into account all possible actions
of rivals

Extension: Game Theory

To explain firms strategic behaviour,
economist often use `game theory`.
While this is not the IB Diploma
Economics program, it may be
covered in the Theory of Knowledge
as The prisoners dilemma.

The Kinked Demand

Curve
One way of attempting to explain the
situation in a non-collusive oligopoly is
the kinked demand curve devised in
the 1930s by an American Economist
called Paul Sweezy (1910-2004).
Although the theory has been called
into question, it does provoke some
interesting thoughts and discussions
concerning non-collusive oligopoly

THE KINKED DEMAND

CURVE
The first assumption is
that a firm only knows one
point on its demand curve,
- the one it holds at
present. This show is
shown as point `a`. If the
firm raises its price, then it
is unlikely that its
competitors would raise
theirs and so a lot of
demand would be lost to
other firms. This implies
that demand would be
If the firm were to lower its price then
it is likely
that above
relatively
elastic
competitors would follow. Competitors
would
the
point
`a`, undercut
since a small
price of the first firm in order to regain any lost sales.
increase in price would
This implies that demand would be less elastic below point a,
to to
large
fall in the
since a decrease in price is unlikelylead
to lead
a noticeable
quantity
increase in quantity demanded. Due
to thesedemanded.
expectations, the
demand curve will be kinked around the point a.

It will also

Kinked Demand Curve & Price

Rigidity in Non-Collusive Oligopoly
The kinked demand curves offers an explanation
of why there tends to be price rigidity in noncollusive oligopoly. There are three reasons:
1. Firms are afraid to raise prices above the
current market price, because other firms will
not follow, and so they lose trade, sales and
probably profit.
2. Firms are afraid to lower their prices below
the current market price, because other firms
will follow, undercutting them an so creating a
price war that may harm all firms involved.

Kinked Demand Curve & Price

Rigidity in Non-Collusive Oligopoly
3. The shape of the MR curve means that if marginal costs
were to rise, then it is possible that MC would still equal
MR and so the firms, being profit maximisers would not
change their prices or outputs.
Based on the kinked demand curve graph, if we assume
that the firm is operating on MC2 then they are
maximising profits by producing at Q and selling at P.
Marginal costs could rise as high as MC 1 and the firm
would still be maximising profits by producing at Q and
charging P. Thus the market remains stable, even
though there have been significant price changes.

NON PRICE COMPETITION

As firms in oligopoly tend not to compete in terms of price
the concept of non-price competition becomes important.
Types of Non Price Competition
Brand names
Packaging
Special Features
Advertising & Sales Promotion
Personal Selling
Publicity
Sponsorship deals
Special Distribution features
(eg: free delivery & after sales service)

Oligopoly and
Advertising
Oligopoly is characterized by very
large advertising and marketing
expenditures as firms try to develop
brand loyalty and make demand for
their product less elastic.
Some may argue that this represents
a misuse of scarce resources, but it
could be argued that competition
among the large companies results in
greater choice for consumers.

The Worlds Leading

Oligopolies
Rivalry among firms in oligopolies are
well known nationally and
internationally:
Eg: Coke / Pepsi and Adidas / Nike.
However many of the branded
consumer goods that we purchase
are produced in oligopolies, which
many consumer would not be aware
of, when shopping.

Unilever and Proctor &

Gamble
Unilever and Proctor & Gamble
produce a vast number of brands
that compete with each other in
number of industries. For example:
home care products, personal
hygiene, health care and beauty
products.

EXAMINATION
QUESTIONS
Short Response
Questions
1.Explain why prices tend
to be quite stable in a
non-collusive oligopoly
(10 marks)

EXAMINATION
QUESTIONS
Essay Questions
1a Distinguish between a
collusive
and non-collusive oligopoly
(10 marks)
1b. Evaluate the view that
governments