Oligopoly

An oligopoly is similar to a monopoly in that there is a small number of firms which have market power meaning that they can influence the price in the market and there is almost no competition.[1] There are a number of types of oligopolistic competition which depend on the type of goods in the market and how competitive the firms want to be in terms of setting prices and quantity but for simplicity it is best examine an oligopolistic market with identical goods where two firms agree to operate as a monopoly. Depending on the type of oligopoly there may be a degree of competition but it falls within certain limits, if one firm begins to compete too much then the oligopoly will cease to function properly.[2] An oligopoly is similar to a monopoly in that they both have very little or no competition and result in an inefficient market.

Oligopolistic Market

The basic assumptions for this model of oligopoly often referred to a cartel or a collusion oligopoly is that the firms sell identical goods and agree to keep the price and quantity produced constant. In doing so, the firms establish a monopolistic market despite there being multiple firms which hold the market power. Because the firms can collectively act as a monopoly, they can set the price and quantity they agreed to.[3]

In this case, assume you go out to get gasoline in your vehicle but instead of there being only one gas station in the city, there are three run by separate firms but they always have the same price so it doesn't affect your choice as to which station you get your gasoline from (assuming they are all identical). The firms agree to sell gas at the same price regardless of the change in input costs from the market such as the price of oil. This has the same effect as one firm owning all the gas stations in the city.

Figure 1. A oligopolistic market with 2 colluding firms.

Figure 1 shows how a collusion oligopoly behaves like a monopoly in a market with the exception of the division of the surplus among the firms in the oligopoly. The Green box is the amount of money made by the oligopoly, in a monopolistic scenario it is kept by one firm but in this case it is split between two firms and can be split between as many firms as there are in the oligopoly.

  • At Point A there is a competitive market in equilibrium, the price (PC) and the quantity (QC) reflect this.
  • At Point B the quantity is reduced from QC to QM but the price rises from PC to PM.
  • At Point B the oligopoly has made less of the good or service available but has also made it more expensive to consumers.
  • The Red Triangle is the deadweight loss, the amount that is lost due to the existence of the oligopoly, this reflects the inefficiency in the market.

Natural Oligopoly

It is common for there to be an oligopoly that emerges for specific markets in the economy such as electricity services, water services or telecommunications services.[4] A natural oligopoly behaves like a natural monopoly and exists as long as one firm does not become too competitive. This is done because it is more efficient for a small number of large firms to provide these services rather than a large number of small firms. See monopoly for the characteristics of a natural oligopoly.

Efficiency Trade-off

Due to the deadweight loss that an oligopoly creates in the market by its nature it is not "economically efficient" but it is nominally efficient. Nominally efficient means that while in theory there could be an efficient market without an oligopoly the nature of the good (electricity) needs to be protected from a certain amount of market forces in order to ensure the steady supply and price. When instituting an oligopoly the society is willing to forego a certain amount of efficiency to guarantee a certain level of utility or satisfaction from electricity or like services.

We forego some market efficiency to maximize the social welfare that public goods like electricity provide. This is a perpetual debate between free market economics and mixed market economics, the goal of which is to decide whether to maximize efficiency which can lead to inequality or to maximize social welfare which seeks to minimize inequalities.[5]

There are some criticisms of the low competition market model as an efficient outcome, see monopoly.

References

  1. A. Goolsbee, S. Levitt and C. Syverson. ‘’Microeconomics’’. New York: Worth Publishers, 2013, pp. 440.
  2. "A Dictionary of Economics" entry: oligopoly, published Oxford University Press, 2013. Edited by John Black, Nigar Hashimzade, and Gareth Myles Online version accessed [August 17th, 2017].
  3. M.A. Utton. Market Dominance and Antitrust Policy, 2nd ed. Cheltenham: Edward Elgar Publishing Limited, 2003, pp. 149-151.
  4. C. Decker. Modern Economic Regulation. Cambridge: Cambridge University Press, 2015, pp. 15.
  5. E.J. Mishan. Economic Efficiency and Social Welfare: Selected Essays on Fundamental Aspects of the Economic Theory of Social Welfare. Milton Park: Routledge, 1981, pp. 3.

Authors and Editors

Lyndon G., Jordan Hanania, Jason Donev
Last updated: August 29, 2017
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