2A) Main economic features of an Oligopoly and key economic theories of price fixing. This part of the coursework aims to identify and explain the main economic features of an Oligopoly and also the key economic theories which influence the price of a product or service. This part deals with the theoretical aspects of Oligopoly and the later part emphasizes on the practical applications of the theories and oligopoly features. According to Pass et al (2000), “Oligopoly, a type of market structure is characterised by a few firms and many buyers, where the bulk of market supply is in the control of relatively few large firms who in turn sell to many small buyers”. To describe the degree of oligopoly, concentration ratio is often utilized. Concentration ratio is the measure of the market share of the largest four firms in the industry expressed as a percentage. A low concentration ratio suggests a high level of competition and vice versa for. As there are few players dominating the industry, each player or an oligopolist is said or likely to be aware of others course of actions. The decision taken by one player seems to affect the decision taken by others and strategic planning by the firms needs to take into account the likely response of other participants (Wikipedia, 2010). For example, a proper game of chess depends on how well you read your opponent’s moves, similarly in oligopoly; strategies are devised based on the moves of competing market firms. The reason for existence oligopoly as stated by Maunder et al (1991) is for the achievement of economies of scale. Firms tend to reduce their average cost of production by increasing their scale of operation and since the small firms have higher average costs, they tend to go out of business or be absorbed by the larger ones. The features of oligopoly are:-
a. Number of Firms:-The very important feature of an oligopoly is the number of firms. Even though there are a large number of firms operating in a particular industry, only a handful of firms hold the major share between them. b. Interdependence: - A very distinctive feature of an oligopoly is interdependence. When a very few large firms operate in a particular industry, their activities or strategy cannot be independent of each other. Unlike monopoly, where the monopolist need not worry about the reaction of its rivals as there are none, an oligopolist takes into consideration the possible reactions of all rival firms. For example, a company considering a price reduction of its products may wish to estimate the chances of price reduction by the rival company and hence starting a price war. c. Profit Maximization Condition: - The firms in an oligopoly generally agree to co-operate and act as one monopolist as it generates high profits (Begg and Ward 2007). This kind of formal collusive agreement is called a cartel. An oligopoly maximises profits where the marginal revenue equals the marginal cost. This is also known as profit maximization condition. Price
PROFIT MAXIMIZING OUTPUT
O MR Quantity
(Source: Begg and Ward 2007)
d. Perfect Knowledge: - Oligopolists are said to have a perfect knowledge about their cost and demand functions but a lesser information about other firms (Wikipedia, 2010). e. Entry Barrier: - One of the main important features of oligopoly also is the entry barrier. There are high entry barriers that restrain a new firm from entering a market. For example, the barriers can be the economies of scale, access to expensive and complex technology, lower costs for an established firm, brand loyalty, patented production process and strategic action by...