written by | November 1, 2022

How are Oligopoly Markets Dominated by Small Number of Suppliers?

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Table of Content


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.

Non-Price Competition

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.

Price-Making Power

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.

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Differentiated Products

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.

Conclusion:

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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FAQs

Q: What can be two barriers to entry in an Oligopoly?

Ans:

Government regulations for procuring licenses, patents, etc., and high research and development costs can be two barriers to a firm's entry into an Oligopoly market.

Q: Why is there less competition in Oligopolies?

Ans:

Due to barriers to entry such as patents, licenses, control over critical raw materials, and so on, a firm can earn supernormal 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.

Q: How are oligopolies divided into different types?

Ans:

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.

Q: What are some of the features of an Oligopoly?

Ans:

Some features of oligopolies are a limited number of firms, interdependence on each other, non-price competition, barriers of entry to new firms, differentiated products, etc.

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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.