Imperfect Competition - Oligopoly

The word “oligopoly” comes from Greek: “oligo” = few, “poly” = sellers. Oligopoly is a market structure in which a small number of firms dominate the market and sell either identical (homogeneous) or differentiated products.

• “Oligopoly is that situation in which a firm bases its market policy in part on the expected behaviour of a few close rivals.”
  — J. Stigler
• “An oligopoly is a market of only a few sellers, offering either homogeneous or differentiated products. There are so few sellers that they recognise their mutual dependence.” — P.C. Dooley

1] Few firms or sellers

• Only a small number of big firms control most of the market supply.
• Each firm has a sizeable market share and can influence price and output.

2] Interdependence of firms

• Each firm’s decisions (about price, output, and advertising) affect the others.
• Before changing price, a firm must think about the likely reaction of its rivals.
• Example: If one telecom company cuts data prices, others quickly respond to avoid losing customers.

3] Importance of advertising and non‑price competition

• Firms often avoid frequent price changes to prevent price wars.
• Instead, they compete through:
  (i) Advertisements,
  (ii) Better quality,
  (iii) Branding and packaging,
  (iv) Extra services, discounts and offers.

4] Barriers to entry

• New firms find it difficult to enter the industry.
• Barriers may include:
  (i) Government licences and regulations,
  (ii) Patents and technology,
  (iii) High capital needs,
  (iv) Strong brand loyalty and economies of scale.

5] Lack of uniformity among firms

• Firms differ in size and strength.
• Some are dominant and large; others are relatively smaller followers.

6] Uncertainty and strategic behaviour

• Firms do not know exactly how rivals will react.
• They may:
  Cooperate and form agreements, or
  Compete aggressively.
  This strategic behaviour creates uncertainty about price and output.

• There is no single, general theory that explains price and output for all types of oligopoly.
• Because firms are few and interdependent, the demand curve of each firm is not clearly known.
• Hence, price and output under oligopoly are called “indeterminate” (not uniquely determined).

1] Conflicting behaviour of firms

• Firms can either:
  Cooperate (collude) to maximise joint profits, or
  Compete fiercely to gain market share.
• Many possible behaviour patterns make outcomes uncertain.

2] Indeterminate demand curve

• Each firm’s demand depends on rivals’ reactions, which are uncertain.
• If one firm changes price, others may match it, ignore it or over‑react.
• Because of this, a stable, definite demand curve cannot be drawn.

3] Profit maximisation is not the only motive

• Besides profit, firms may aim for:
  (i) Sales maximisation,
  (ii) Market share growth,
  (iii) Risk minimisation,
  (iv) Long‑term security and stability.
• Multiple motives make prediction of price–output decisions difficult.

4] Different institutional arrangements

• Oligopolistic industries may have:
  (i) Tacit or open collusion,
  (ii) Gentlemen’s agreements,
  (iii) Dominant firm (price leader) structures,
  (iv) Various informal understandings.
• Because arrangements differ across industries, there is no single rule for price and output.

5] Oligopolistic interdependence

• Every firm knows its decisions affect others and that others will respond.
• This mutual dependence complicates each firm’s decision‑making process.

6] Oligopolistic uncertainty and “outguessing”

• Managers must think about how rivals will react and how rivals think they will react.
• Firms try to “outguess” each other, which increases uncertainty.

7] Price rigidity and non‑price competition

• Prices are often rigid: once set, they remain unchanged for long periods.
• Reasons:
  (i) If a firm raises price, it may lose customers.
  (ii) If it cuts price, rivals may also cut, starting a price war.
• Therefore, firms keep price stable and compete using quality, design, service and advertising.
• The kinked demand curve model is one attempt to explain this price rigidity.

8] Existence of non‑profit motives

• Real‑world firms may not always calculate exact marginal cost and marginal revenue.
• Non‑profit objectives (stability, survival, and risk reduction) also influence decisions.
• This makes it hard to get a clear, unique equilibrium price and output.

9] Conflicting attitudes of firms

• Sometimes firms see the benefit of cooperation and move towards joint profit maximisation.
• At other times, they focus on beating rivals and increasing their own profits.
• This constant tension between cooperation and conflict leads to indeterminacy.

• Oligopoly: A market with a few dominant firms, high interdependence, and barriers to entry.
• Firms compete both by price and by non‑price methods (advertising, quality, branding).
• Price rigidity and non‑price competition are typical features of oligopolistic markets.