An oligopoly is defined as a market structure wherein industries are dominated or handled by “few” firms. Oligopolistic market structure dominates the market structures available, accounting half of the total outputs in the world. Industries which adapt to these vary from manufacturers of automobiles to breakfast cereal or even television broadcasting to airlines.
In the words of Robert Y. Awh, “Oligopoly is that market structure in which a few sellers who clearly recognize their mutual interdependence produce the bulk of the market output”.
Oligopoly differs from other market categories in that, under monopoly we have only one seller, under perfect competition we have many sellers, under monopolistic competition we has a sufficiently large group of small monopolists whereas under oligopoly we have a few sellers constituting a small group. In an Oligopolistic market the firms may be producing either homogeneous or differentiated products. Besides, the element of interdependence among rival firms in the group makes it difficult for us to have a general theory of the oligopoly. In oligopoly the action of one firm depends not only on the reaction of the consumers but also on the reaction of rival firms. Thus decision-making becomes a complicated phenomenon. Before a firm makes any decision it has to take into account the probable reaction of the rival firms.
Classification of Oligopoly
Oligopoly can be classified into a number of categories on the following basis :
- On the basis of product differentiation, we can have either pure oligopoly or differentiated oligopoly. In case of pure-oligopoly, the products of different firms in the group will be identical. There is no element of product differentiation. In case of differentiated oligopoly, the competing firms produce products which are not identical. There is product-differentiation.
- On the basis of entry of firms, we may classify oligopoly as open oligopoly and closed oligopoly. In open oligopoly the firms are free to enter the market. There is no restriction of any kind for a firm to enter the group producing very close substitute. This implies absence of any barriers to entry of a new firm. In case of closed oligopoly there are barriers to the entry of a new firm. No new firms are able to enter the existing group.
- On the basis of the presence or absence of price-leadership, we may classify oligopoly into partial or full oligopoly. In case of partial oligopoly there is one price-leader. He takes the decision regarding prices and the rest of the firms ‘follow the leader’. In case of full oligopoly there is no leader and no follower. Every producer takes his own decision regarding the fixation of price.
- On the basis of deliberate agreement, oligopoly may be classified as collusive oligopoly and non-collusive oligopoly. Under collusive oligopoly firms establish a virtual monopoly by agreeing upon one common uniform price in the market. They, combine together in order to avoid any cut-throat price competition. This is called collusion. This practice of collusion has been quite an illegal practice. If firms do not formally agree to get one price, the same result may be worked out through ‘Understood’ informal collusion. In case of non-collusive oligopoly the firms do not take a common uniform decision regarding price-policy. Each firm takes its own decision.
Characteristics of Oligopoly
- Competition among the Few : There are just a few sellers under oligopoly. The number could be more than one but not very many. In case there are only two sellers then such a market category is called Duopoly. Duopoly is perhaps a special case of oligopoly.
- Interdependence among rival firms : Interdependence is an integral part of Oligopoly. In case of perfect competition, a firm is a price-taker. Each firm has to take the price which prevails in the market. Under oligopoly the situation is quite different. Each firm has to take into account the actions and reactions of other firms while formulating its price policy. Before an oligopolist decides to fix or change the price of his product he must study the ‘moves’ which his rivals are likely to make in the market.
- Possibility of Collusion : In order to avoid any cut-throat retaliation among the firms through price-cutting, the firms decide to come together and unanimously agree to adopt a uniform price policy. Thus collusion is normally likely to be practical under oligopoly.
- Rigidity in Pricing : Even in the absence of collusion of any type, there is resistance to price changes among oligopolists. For if one oligopolist lowers the price of his product to increase its demand by taking away his rival’s clientele then the rival oligopolist will also resort to the policy of scaling down the price of his product to win back and attract more of the other’s customers. Thus a price-war starts. This retaliation in price-cutting would reduce the profits of all the oligopolists. Thus the inevitable threat of price-cutting leads to price-rigidity.
- Barriers to Entry : One of the essential features of oligopoly is the difficulty on the part of new firms to enter the market. Entry barriers resulting from mergers, ownership and control of key factors of production and the advantage of having been ‘established’ and enjoying scale economies are significant elements in maintaining the dominance of the existing few firms in the oligopolistic market.
- Excessive Expenditure on Advertisement: Advertising and selling costs are of strategic importance to oligopolists. To quote Baumol. “It is only under oligopoly that advertising comes fully into its own.”
- Indeterminateness: Interdependence of the firms and the firm’s reaction against each other’s policy formulation poses several problems in the determination of price and output. There is a wide spectrum of oligopolist behavior. To quote Baumol, “Rivals may decide to get together and co-operate in the pursuit of their objectives, at least so far as the law allows or, at the other extreme, they may fight each other to death. Even if they enter into an agreement it may last or it may break down. The agreements may follow a wide variety of patterns.” As a result of this interdependence the demand curve of the oligopolist firm itself displays an element of indeterminateness. Once the oligopolist decides to alter the price of his product it will influence the demand for it in the market. But the rivals will also retaliate (or at times remain docile), which in turn will affect the demand of the firm which earlier charged its price. Thus the demand curve of the firm is indeterminate and therefore there creeps in an element of indeterminancy regarding the price-output policy of an oligopolist.
- The Kinky Demand Curve: One of the most distinguishing features of Oligopoly is the Kinky demand curve. Under Oligopoly the AR curve has a peculiar shape and AR and MR bear some unique relationship. The concept of the Kinky demand curve is more associated with the name of Paul M. Sweezy. The market situation contemplated by Sweezy is one in which rivals will quickly match price reductions but only hesitantly and incompletely (if at all) follow price increase and this leads to the kinky demand curve.
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