Oligopolies

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Oligopoly

An oligopoly is an industry which is dominated by a few firms.

A few firms with a high concentration ratio and significant price-setting power.
Supernormal profit in the short-run and long-run.
Barriers to entry are relatively high.
Product differentiation.
Interdependence between firms. But they can often implement collusive strategies.
Oligopoly can be defined through either its conduct (collusive or competitive), or its structure.

Concentration ratios measure the power of the firms in an oligopoly.
- If there are four firms in an oligopoly that take up 76% of the market, then the four-firm concentration ratio is 76%.
The n-firm concentration ratio is a measure of market structure. It combines the market share of the top n firms as a % of the total market.
- E.g If the top 3 firms control 80% of a market, the 3-firm concentration ratio is 0.8.

Firms in an oligopoly are interdependent. Their pricing and product strategies depend on the behaviour of the other firms.
The prisoners' dilemma shows us that firms can receive a greater payoff by colluding.
Firms can agree to raise prices.
- Formal collusion: a spoken agreement between firms to keep prices high.
- Tacit collusion: an unspoken agreement between firms. Tacit collusion often works through price leadership. Here, it is in both firms best interest not to change prices.

In a non-collusive oligopoly, firms compete with each other on a number of factors, including price.
Non-collusive oligopolies are a common type of market structure.

Non-collusive oligopolies are more likely when we see:
- Low entry barriers, a high number of firms, and different marginal costs.
Collusive oligopolies are more likely when we see:
- High entry barriers, low number of firms, and similar marginal costs.

The nature of the oligopoly can have an impact on the firms within it, as well as the consumers.

Firms in an oligopoly may engage in a price war.
By fiercely cutting prices (sometimes called 'predatory pricing'), firms are trying to gain market share.
The idea is that by aggressively cutting prices, you will drive other firms out of the market because they can no longer compete.
New firms will be discouraged to enter because of the low profits being made.
Once firms have been driven out of the market, non-price competition can be used to maintain market share.

Informal collusion is less likely than it may appear, as one firm tends to defect, which brings down the entire cartel.
This could lead to price wars, which are good for consumers due to the lower prices.
Collusive oligopolies can achieve dynamic efficiency through non-price competition and product development.
Competitive oligopolies also have the potential to be very efficient.

Due to their size and the fact that they often spend large amount on advertising, many firms and oligopoly industries are well-known:

Technically, a market with two dominant sellers is called a duopoly.
However, the interdependence and behaviour of these firms would be the same with three or more sellers and so Coca-Cola and Pepsi could be considered here.
They have such strong brands that barriers to entry are very high and they also have strong price-setting power.
Coca-Cola and Pepsi are also very dependent on each other in terms of their price and promotion levels.

Although this has since reduced, the 'Big Six' UK energy providers controlled virtually all of the gas and electricity markets.
They have been accused of price fixing by politicians and made such large profits that there were calls for a special, one-off tax on these.
The CMA has investigated this industry recently and it is under constant scrutiny.
There are high barriers to entry and brand loyalty, mainly due to customers not switching to cheaper suppliers when this is possible.

There are several main mobile phone service providers in the UK, including Vodafone, EE, O2, etc.
There are high barriers to entry due to the need to have a licence to operate and these firms spend heavily on marketing and promotions to gain customers.
BT bought EE for £12.5bn after the CMA approved the deal, deciding that it would not cause there to be a substantial reduction in the level of competition.