Oligopoly

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An oligopoly is a market form in which a market or industry is dominated by a small
number of sellers (oligopolists). The word is derived, by analogy with "monopoly", from
the Greek ὀλίγοι (oligoi) "few" + πωλειν (polein) "to sell". Because there are few
sellers, each oligopolist is likely to be aware of the actions of the others. The decisions of
one firm influence, and are influenced by, the decisions of other firms. Strategic planning
by oligopolists needs to take into account the likely responses of the other market
participants.
Contents
[hide]

• 1 Description

• 2 Χηα ρ α χ τ ε ρ ι σ τ ι χ σ

• 3 Μο δ ε λ ι ν γ

• 3.1 Dominant firm model

• 3.2 Χ ο υ ρ ν ο τ − Ν α σ η
µο δ ε λ

• 3.3 Β ε ρ τ ρ α ν δ µο δ ε λ

3.4 Κ ι ν κ ε δ δεµαν δ
χυρϖ ε µο δ ε λ

• 4 Examples

• 4.1 Australia

• 4.2 Χ α ν α δ α

• 4.3 Υ ν ι τ ε δ Κιν γ δ ο µ

• 4.4 Υ ν ι τ ε δ Στα τ ε σ

4.5 Ω ο ρ λ δ ω ι δ ε

• 5 Demand curve

• 6 Σε ε αλσ ο

• 7 Νο τ ε σ

8 Εξ τ ε ρ ν α λ λινκ σ

[edit] Description
Oligopoly is a common market form. As a quantitative description of oligopoly, the four-
firm concentration ratio is often utilized. This measure expresses the market share of the
four largest firms in an industry as a percentage. For example, as of fourth quarter 2008,
Verizon, AT&T, Sprint Nextel, and T-Mobile together control 89% of the US cellular
phone market.
Oligopolistic competition can give rise to a wide range of different outcomes. In some
situations, the firms may employ restrictive trade practices (collusion, market sharing
etc.) to raise prices and restrict production in much the same way as a monopoly. Where
there is a formal agreement for such collusion, this is known as a cartel. A primary
example of such a cartel is OPEC which has a profound influence on the international
price of oil.
Firms often collude in an attempt to stabilize unstable markets, so as to reduce the risks
inherent in these markets for investment and product development.[citation needed]
There are legal restrictions on such collusion in most countries. There does not have to be
a formal agreement for collusion to take place (although for the act to be illegal there
must be actual 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.
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. The competition in an oligopoly can be greater than
when there are more firms in an industry if, for example, the firms were only regionally
based and did not compete directly with each other.
Thus the welfare analysis of oligopolies is sensitive to the parameter values used to
define the market's structure. In particular, the level of dead weight loss is hard to
measure. The study of product differentiation indicates that oligopolies might also create
excessive levels of differentiation in order to stifle competition.
Oligopoly theory makes heavy use of game theory to model the behavior of oligopolies:

• Stackelberg's duopoly. In this model the firms move sequentially (see Stackelberg
competition).

• Χ ο υ ρ ν ο τ 's duopoly. In this model the firms simultaneously choose

quantities (see Cournot competition).

• Β ε ρ τ ρ α ν δ 's oligopoly. In this model the firms simultaneously choose

prices (see Bertrand competition).

[edit] Characteristics
Profit maximization conditions: An oligopoly maximizes profits by producing where
marginal revenue equals marginal costs.[1]
Ability to set price: Oligopolies are price setters rather than price takers.[1]
Entry and exit: Barriers to entry are high.[2] The most important barriers are economies
of scale, patents, access to expensive and complex technology, and strategic actions by
incumbent firms designed to discourage or destroy nascent firms.[3]
Number of firms: "Few" – a "handful" of sellers.[2] There are so few firms that the
actions of one firm can influence the actions of the other firms.[4]
Long run profits: Oligopolies can retain long run abnormal profits. High barriers of
entry prevent sideline firms from entering market to capture excess profits.
Product differentiation: Product may be standardized (steel) or differentiated
(automobiles).[5]
Perfect knowledge: Assumptions about perfect knowledge vary but the knowledge of
various economic actors can be generally described as selective. Oligopolies have perfect
knowledge of their own cost and demand functions but their inter-firm information may
be incomplete. Buyers have only imperfect knowledge as to price,[2] cost and product
quality.
Interdependence: The distinctive feature of an oligopoly is interdependence.[6]
Oligopolies are typically composed of a few large firms. Each firm is so large that its
actions affect market conditions. Therefore the competing firms will be aware of a firm's
market actions and will respond appropriately. This means that in contemplating a market
action, a firm must take into consideration the possible reactions of all competing firms
and the firm's countermoves.[7] It is very much like a game of chess or pool in which a
player must anticipate a whole sequence of moves and countermoves in determining how
to achieve his objectives. For example, an oligopoly considering a price reduction may
wish to estimate the likelihood that competing firms would also lower their prices and
possibly trigger a ruinous price war. Or if the firm is considering a price increase, it may
want to know whether other firms will also increase prices or hold existing prices
constant. This high degree of interdependence and need to be aware of what the other guy
is doing or might do is to be contrasted with lack of interdependence in other market
structures. In a PC market there is zero interdependence because no firm is large enough
to affect market price. All firms in a PC market are price takers, information which they
robotically follow in maximizing profits. In a monopoly there are no competitors to be
concerned about. In a monopolistically competitive market each firm's effects on market
conditions is so negligible as to be safely ignored by competitors.

[edit] Modeling
There is no single model describing the operation of an oligopolistic market.[7] The
variety and complexity of the models is due to the fact that you can have two to 102 firms
competing on the basis of price, quantity, technological innovations, marketing,
advertising and reputation. Fortunately, there are a series of simplified models that
attempt to describe market behavior under certain circumstances. Some of the better-
known models are the dominant firm model, the Cournot-Nash model, the Bertrand
model and the kinked demand model

[edit] Dominant firm model

In some markets there is a single firm that controls a dominant share of the market and a
group of smaller firms. The dominant firm sets prices which are simply taken by the
smaller firms in determining their profit maximizing levels of production. This type of
market is practically a monopoly and an attached perfectly competitive market in which
price is set by the dominant firm rather than the market. The demand curve for the
dominant firm is determined by subtracting the supply curves of all the small firms from
the industry demand curve.[8] After estimating its net demand curve (market demand less
the supply curve of the small firms) the dominant firm maximizes profits by following
the normal p-max rule of producing where marginal revenue equals marginal costs. The
small firms maximize profits by acting as PC firms–equating price to marginal costs.

[edit] Cournot-Nash model

Main article: Cournot competition
The Cournot-Nash model is the simplest oligopoly model. The models assumes that there
are two “equally positioned firms”; the firms compete on the basis of quantity rather than
price and each firm makes an “output decision assuming that the other firm’s behavior is
fixed.”[9] The market demand curve is assumed to be linear and marginal costs are
constant. To find the Cournot-Nash equilibrium one determines how each firm reacts to a
change in the output of the other firm. The path to equilibrium is a series of actions and
reactions. The pattern continues until a point is reached where neither firm desires “to
change what it is doing, given how it believes the other firm will react to any
change.”[10] The equilibrium is the intersection of the two firm’s reaction functions. The
reaction function shows how one firm reacts to the quantity choice of the other firm.[11]
For example, assume that the firm 1’s demand function is P = (60 - Q2) - Q1 where Q2 is
the quantity produced by the other firm and Q1 is the amount produced by firm 1.[12]
Assume that marginal cost is 12. Firm 1 wants to know its maximizing quantity and
price. Firm 1 begins the process by following the profit maximization rule of equating
marginal revenue to marginal costs. Firm 1’s total revenue function is PQ = Q1(60 - Q2 -
Q1) = 60Q1- Q1Q2 - Q12. The marginal revenue function is MR = 60 - Q2 - 2Q.[13].

MR = MC
60 - Q2 - 2Q = 12

2Q = 48 - Q2

Q1 = 24 - 0.5Q2 [1.1]

Q2 = 24 - 0.5Q1 [1.2]

Equation 1.1 is the reaction function for firm 1. Equation 1.2 is the reaction function for
firm 2.
To determine the Cournot-Nash equilibrium you can solve the equations simultaneously.
The equilibrium quantities can also be determined graphically. The equilibrium solution
would be at the intersection of the two reaction functions. Note that if you graph the
functions the axes represent quantities.[14] The reaction functions are not necessarily
symmetric.[15] The firms may face differing cost functions in which case the reaction
functions would not be identical nor would the equilibrium quantities.
[edit] Bertrand model
Main article: Bertrand competition
The Bertrand model is essentially the Cournot-Nash model except the strategic variable is
price rather than quantity.[16]
The model assumptions are:
There are two firms in the market
They produce a homogeneous product
They produce at a constant marginal cost
Firms choose prices PA and PB simultaneously

Firms outputs are perfect substitutes

Sales are split evenly if PA = PB[17]

The only Nash equilibrium is PA = PB = MC.

Neither firm has any reason to change strategy. If the firm raises prices it will lose all its
customers. If the firm lowers price P < MC then it will be losing money on every unit
sold.[18]
The Bertrand equilibrium is the same as the competitive result.[19] Each firm will
produce where P = marginal costs and there will be zero profits.[16]

[edit] Kinked demand curve model

According to this model, each firm faces a demand curve kinked at the existing price.[20]
The conjectural assumptions of the model are; if the firm raises its price above the current
existing price, competitors will not follow and the acting firm will lose market share and
second if a firm lowers prices below the existing price then their competitors will follow
to retain their market share and the firm's output will increase only marginally.[21]
If the assumptions hold then:
The firm's marginal revenue curve is discontinuous, and has a gap at the kink[20]
For prices above the prevailing price the curve is relatively elastic [22]
For prices below the point the curve is relatively inelastic [22]
The gap in the marginal revenue curve means that marginal costs can fluctuate without
changing equilibrium price and quantity.[20] Thus prices tend to be rigid.
[edit] Examples
In industrialized economies, barriers to entry have resulted in oligopolies forming in
many sectors, with unprecedented levels of competition fueled by increasing
globalization. Market shares in an oligopoly are typically determined by product
development and advertising. For example, there are now only a small number of
manufacturers of civil passenger aircraft, though Brazil (Embraer) and Canada
(Bombardier) have participated in the small passenger aircraft market sector. Oligopolies
have also arisen in heavily-regulated markets such as wireless communications: in some
areas only two or three providers are licensed to operate.

[edit] Australia
• Phone lines are controlled by Telstra, then rented to other providers and further
rented to customers. Any rate hikes by Telstra are felt by all customers with a
phone line no matter the provider.

• Most media outlets are owned either by News Corporation, Time Warner, or by
Fairfax MediaHYPERLINK "http://en.wikipedia.org/wiki/Oligopoly" \l
"cite_note-22"[23]

• Grocery retailing is dominated by Coles Group and Woolworths.[citation needed]

[edit] Canada
• Three companies (Rogers Wireless, Bell Mobility and Telus) share over 94% of
Canada's wireless market.[24]HYPERLINK
"http://en.wikipedia.org/wiki/Oligopoly" \l "cite_note-24"[25]

[edit] United Kingdom

• Four companies (Tesco, Sainsbury's, Asda and Morrisons) share 74.4% of the
grocery market.[26]

• The detergent market is dominated by two players, Unilever and Procter &
Gamble.[27]

[edit] United States

• Many media industries today are essentially oligopolies.

• Six movie studios receive 90% of American film revenues.[citation

needed]

• The television industry is mostly an oligopoly of eight companies: The

Walt Disney Company, CBS Corporation, Viacom, NBC Universal,
Comcast, Hearst Corporation, Time Warner, and News Corporation.[28]
See Concentration of media ownership.
 • Four major music companies receive 80% of recording revenues.[citation
needed]

• Four wireless providers (AT&T, Verizon Wireless, T-Mobile, Sprint)

control 89% of the cellular telephone market.[29]

• There are six major book publishers.[citation needed]

• Healthcare insurance in the United States consists of very few insurance

companies controlling major market share in most states. For example,
California's insured population of 20 million is the most competitive in the nation
and 44% of that market is dominated by two insurance companies, Anthem and
Kaiser Permanante. [30]

• Αν η ε υ σ ε ρ − Βυσ χ η and MillerCoors control about 80% of the beer

industry.[31]

• Detroit's Big Three were leaders in the auto industry for many years. However
globalization and demand for foreign imports have driven down sales sharply in
recent years.[citation needed]

[edit] Worldwide
• The accountancy market is controlled by PriceWaterhouseCoopers, KPMG,
Deloitte Touche Tohmatsu, and Ernst & Young (commonly known as the Big
Four)[32]

• Three leading food processing companies, Kraft Foods, PepsiCo and Nestle,
together achieve a large proportion[vague] of global processed food sales. These
three companies are often used as an example of "The rule of 3"[33], which states
that markets often become an oligopoly of three large firms.

• Βο ε ι ν γ and Airbus have a duopoly over the airliner market[34]

[edit] Demand curve

Above the kink, demand is relatively elastic because all other firms' prices remain
unchanged. Below the kink, demand is relatively inelastic because all other firms will
introduce a similar price cut, eventually leading to a price war. Therefore, the best option
for the oligopolist is to produce at point E which is the equilibrium point and the kink
point. This is a theoretical model proposed in 1947, which has failed to receive
conclusive evidence for support.
In an oligopoly, firms operate under imperfect competition. With the fierce price
competitiveness created by this sticky-upward demand curve, firms use non-price
competition in order to accrue greater revenue and market share.
"Kinked" demand curves are similar to traditional demand curves, as they are downward-
sloping. They are distinguished by a hypothesized convex bend with a discontinuity at the
bend–"kink". Thus the first derivative at that point is undefined and leads to a jump
discontinuity in the marginal revenue curve.
Classical economic theory assumes that a profit-maximizing producer with some market
power (either due to oligopoly or monopolistic competition) will set marginal costs equal
to marginal revenue. This idea can be envisioned graphically by the intersection of an
upward-sloping marginal cost curve and a downward-sloping marginal revenue curve
(because the more one sells, the lower the price must be, so the less a producer earns per
unit). In classical theory, any change in the marginal cost structure (how much it costs to
make each additional unit) or the marginal revenue structure (how much people will pay
for each additional unit) will be immediately reflected in a new price and/or quantity sold
of the item. This result does not occur if a "kink" exists. Because of this jump
discontinuity in the marginal revenue curve, marginal costs could change without
necessarily changing the price or quantity.
The motivation behind this kink is the idea that in an oligopolistic or monopolistically
competitive market, firms will not raise their prices because even a small price increase
will lose many customers. This is because competitors will generally ignore price
increases, with the hope of gaining a larger market share as a result of now having
comparatively lower prices. However, even a large price decrease will gain only a few
customers because such an action will begin a price war with other firms. The curve is
therefore more price-elastic for price increases and less so for price decreases. Firms will
often enter the industry in the long run.