Oligopoly Quiz: Test Your Knowledge with Practice Questions

Understanding Oligopolies: Market Dominated by a Small Number of Sellers

An oligopoly is a market structure where a few large sellers control the industry, with homogenous products, few market participants, and inelastic demand.
Firms in oligopolistic markets have significant market power and tend to influence prices through manipulating the supply function.
Firms can resort to collusion to maximize profits, but this is illegal in many jurisdictions and is regarded as anti-competition behavior.
Oligopolies exist in many industries, including civil aviation, electricity providers, telecommunications, rail freight markets, food processing, funeral services, sugar refining, beer making, pulp and paper making, and automobile manufacturing.
Collusion can only be proven through actual and direct communication between companies, which means corporations can evade legal consequences through tacit collusion.
Oligopolies can develop without collusion and in the presence of fierce competition among market participants, where oligopolists have their own market structure.
Perfect and imperfect oligopolies are distinguished by the nature of the goods the firms produce or trade in.
An open oligopoly market structure is considered to occur where the barriers to entry do not exist, while a closed oligopoly has prominent barriers to market entry.
A tight oligopoly has a few firms dominating the market, while a loose oligopoly has many firms but they are all interdependent and often collude to maximize their profits.
The barriers to enter into an oligopoly market are a fundamental source of an oligopoly's power, as large capital investments required for entry, intellectual property laws, certain network effects, absolute cost advantages, reputation, advertisement dominance, product differentiation, brand reliance, and others preclude new firms from entering.
There is no single model describing the operation of an oligopolistic market, but there are a series of simplified models that attempt to describe market behavior by considering certain circumstances.
Game theory is used heavily in oligopoly theory to model the behavior of oligopolies, where the decisions of one firm influence and are influenced by the decisions of other firms.Bertrand Model: An Overview
The Bertrand model is a game theory model used to explain oligopoly.
The model assumes that firms sell homogeneous products and have the same marginal production costs.
The strategic variable in the Bertrand model is price, not quantity.
Firms will compete in prices simultaneously, with the goal of reaching an equilibrium where the price they charge is the same as their marginal cost of production.
Firms have strong incentives to undercut their competitors in prices to grab the whole market profits.
Even highly rational, selfish firms would not be able to stay at a price higher than marginal cost.
The Nash equilibrium approach is a relatively efficient analytical tool to predict prices, although it lacks the ability to capture human behavioral patterns.
The only Nash equilibrium in the Bertrand model is when the price of both firms equals the marginal cost of production.
If a firm raises prices, it will lose all its customers. If it lowers prices, it will gain all the market share.Understanding Oligopoly: Models, Assumptions, and Possible Outcomes
Oligopoly is a market structure in which a small number of firms dominate the market.
Two of the most well-known models in oligopoly theory are the Cournot model and the Bertrand model.
The Cournot model assumes that firms choose their output levels simultaneously, while the Bertrand model assumes that firms choose their prices simultaneously.
The Cournot-Bertrand model is a hybrid of the Cournot and Bertrand models, allowing for the market to be split into two groups of firms, one adjusting output and the other adjusting prices.
The kinked demand curve model is a theory of oligopoly that assumes firms will not raise their prices because they will lose many customers, but nor will they lower their prices because such an action will begin a price war with other firms.
The four-firm concentration ratio is often utilized to analyze market concentration, expressing the market share of the four largest firms in any particular industry.
International oligopolies must consider importing and exporting tariffs as countries have different international policies.
Oligopolistic competition can give rise to a wide range of outcomes, including the formation of cartels, which are now regulated by anti-competitive practice laws.
Competition between sellers in an oligopoly can be fierce, leading to an efficient outcome approaching perfect competition, with relatively low prices and high production.
The welfare analysis of oligopolies is sensitive to the parameter values used to define the market's structure.
The kinked demand curve model suggests that prices would be relatively stable, and that firms will have little motivation to adjust their pricing in the near future, instead competing using strategies other than price competition.
Profit would be maximized if marginal revenue equaled marginal cost.Overview of Oligopoly Markets
The MR (Marginal Revenue) of an oligopoly market is equal to the MC (Marginal Cost).
Price reductions can significantly increase market share, but it is unlikely that firms will accept this.
Demand for a price reduction is inelastic, and demand is very elastic in response to price increases.
Kinked demand strategies serve as a mechanism for enforcing compliance with a collusive price leadership strategy.
Oligopolies can have pricing competition among their members, especially if they want to expand their market share.
Examples of oligopolistic industries include civil aviation, agricultural pesticides, electricity, platinum group metal mining, telecommunications, rail freight markets, food processing, funeral services, sugar refining, beer making, pulp and paper making, and automobile manufacturing.
Market power and concentration can be estimated or quantified using various tools such as the Lerner index, stochastic frontier analysis, and New Empirical Industrial Organization (NEIO) modeling, as well as the Herfindahl-Hirschman index.