An oligopoly is a market structure in which a small number of firms can prevent others from wielding significant influence. The concentration ratio calculates the most prominent firms' market share. In this, some large firms or corporations control the market by trade practices such as market sharing and cooperation and also putting in different barriers to entry. In this market, the profit can be increased through non-price competition and product differentiation. Oligopolists control prices rather than the market because they offer comparable products or services. It is carried through cooperation by raising the prices and reducing the output or options for the consumers. Instilling a sense of rivalry encourages existing brands to improve product quality and originality.
Did you know? A rule of thumb is that an oligopoly exists when the top five firms in the market account for more than 60% of total market sales.
Structure of an Oligopoly Market
The number of businesses, price control, and barriers to market entry is all factors that influence market structure. In a monopoly, only one large brand has complete control over the market. When two major players dominate a market, the market is said to be a duopoly. They concentrate on each other and strive to exceed customer expectations in every way possible. In an oligopoly, a few dominant brands provide the majority of the products and services and make major decisions on behalf of the others.
Oligopolists are not in competition with one another. They instead collaborate on various fronts, including economies of scale, market demand, and product differentiation. They reduce output while raising prices, and this is known as collusion.
A cartel is a group of people who work together to achieve a common goal. However, this system is considered inappropriate and illegal in some parts of the world as it involves mutually agreed price fixing, increased technical and quality standards, and other practices. In an Oligopoly, price collusion occurs, which enables to put different barriers to entry. These barriers for new entrants can be in the form of legal regulations, high capital requirements, high research and development cost, customer loyalty, etc.
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Features of an Oligopoly Market
There are several features of an oligopoly. The same has been given below in detail-
A limited number of firms
There are a few large firms under oligopoly, but the exact number of firms is unknown. Furthermore, there is fierce competition because each firm produces a significant portion of the total output.
Restrictions on entry of new firms or Barriers to Entry
Because of barriers to entry such as patents, licenses, control over critical raw materials, and so on, a firm can earn super-normal profits in the long run under an oligopoly. These impediments prevent new firms from entering the industry. As a result, the competition is limited to those already in the group. Oligopolist control over specialized inputs like resources, price, and production makes it difficult for a new firm to survive.
In this market, firms are not involved in price competition. Instead, their focus is on earning customers or increasing their sales through different strategies such as differentiated products, offering discounts or rewards to customers, using various promotion schemes, acting as sponsors, and so on. They do it strategically to avoid losing customers in a possible price war.
Interdependence on each other
Because a few firms control a sizable portion of the industry's output, rival firms' price and output decisions affect each. As a result, firms in an oligopoly are highly interdependent. As a result, when determining its price and output levels, a firm considers the action and reactions of its competitors.
In an oligopoly, dominant market players have enough clout to set product and service prices. And the rest of the companies or minor players do the same. It aids in avoiding a price war and price rigidity. All firms adhere to the decision, ensuring price stability in the sector.
One of the characteristics of an oligopoly is the focus of its members on improving product quality or offering benefits to differentiate its brand. Even though the products of companies A and B are similar, something must set them apart. In an oligopolistic industry, this becomes the unique selling proposition (USP) of the respective brands.
Types of Oligopolies
Oligopolies can be divided based on several factors, such as openness of the market, nature of the product, structure, and functioning of the market, degree of collaboration between the vendors, etc.
The different types have been discussed below in detail-
The openness of the market
1. Open Market- Any new firm attempting to enter can compete with existing firms to gain a foothold.
2. Closed Market- New players cannot enter the market as entry is restricted.
Nature of the Market
- Pure Oligopoly: This type of Oligopoly contains homogeneous products. E.g.:- Aluminum Industry
- Differentiated Oligopoly: This type of Oligopoly has products that are differentiated. E.g.:- Talcum Powder Industry
Functioning of the Market
- Full - In this type, there is no vendor which controls the price, all the players in the market have more or less the same price
- Partial- In this type, one big firm controls the price, and all the others work according to that.
Collaboration between Vendors
1. Competitive - In this type, the vendors compete with each other rather than cooperating.
2. Collusive- The firms work together and control the product output and market price of the product
Fixing of the product price
- Organized Oligopoly: It is where all the firms work with each other to fix the price, sale, output, etc.
- Syndicated Oligopoly: It is one in which a small group or individual firm controls the sale of products.
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Kinked Demand Curve
Firms in an oligopoly market prioritize non-price competition and less innovation while ensuring their brands are easily identified. They believe in retaining customers for core competencies rather than lowering prices to increase profits and market share. Despite having the same market share, oligopolists are influenced by each other's decisions, such as price cuts and increases, due to the smaller number of firms.
The downward-sloping Kinked demand curve best explains how oligopolists react to a price change by one firm. Kink occurs when an upward-sloping marginal cost curve intersects a downward-sloping marginal revenue curve, resulting in a convex bend.
To avoid price rigidity, firms do not raise prices. However, they match the price if a price reduction occurs. However, too much price reduction can result in a price war. As a result, to maximize revenue, each firm is obligated to adhere to pre-determined price and quantity/output levels. As a result, others follow suit when an oligopolist lowers costs to increase output. If, on the other hand, an oligopolist reduces output by raising prices, the rest do not. As a result, each firm gains a sizable market share while incurring minimal potential profits.
Example of Oligopoly
An example of an Oligopoly has been discussed below-
An exceptional example of an Oligopoly is the soft drinks industry. In India, there are a handful of firms that manufacture cold drinks.
Since these are similar products, they need to make sure that they provide customers with something better than the other. Hence, they constantly keep improving their products and bringing variants to retain and attract customers. In this sense, they ensure there is no price competition between them.
An oligopoly is a market structure in which a few large firms collaborate to dominate a specific market segment. Because there is little competition among them, each influences the others through their actions and decisions. In an oligopolistic market, market participants focus on non-price competition, ensure their brands are easily identifiable, and use hidden advertising tactics.
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