Oligopoly

Features of Oligopoly

  • An industry which is dominated by a few firms.
    • UK definition of an oligopoly is a five firm concentration ratio of more than 50% (this means they have more than 50% of the market share)
  • Interdependence of Firms, firms will be effected by how other firms set price and output
  • Barriers To Entry, but less than Monopoly
  • Differentiated Products, advertising is often important
  • Most Common Market Structure

Definition of Concentration Ratios:
This is a tool for measuring the market share of the 5 biggest firms in the industry. E.g. the 5 firm concentration ratio for supermarkets is about 58%

How Firms In Oligopoly are Expected to behave

There are different possible ways that firms in oligopoly will compete and behave this will depend upon:

  • the objectives of the firms e.g. profit max or sales max
  • the degree of contestability i.e. barriers to entry
  • government regulation

The Kinked Demand Curve Model

The Kinked Demand Curve Graph

kinked 

  • This assumes that firms seek to maximise profits
  • If they increase price, then they will lose a large share of the market because they become uncompetitive compared to other firms, therefore demand is elastic for price increases.
  • If firms cut price then they would gain a big increase in Market share, however it is unlikely that firms will allow this. Therefore other firms follow suit and cut price as well. Therefore demand will only increase by a small amount: Demand is inelastic for a price cut
  • Therefore this suggests that prices will be rigid in Oligopoly

The below diagram suggests that a change in Marginal Cost still leads to the same price, because of the kinked demand curve( remember profit max occurs where MR = MC

Diagrams for Oligopoly