‘Oligopoly is an industry structure characterized by a few firms producing all, or most, of the output of some good that may or may not be differentiated.book’ An oligopoly lies somewhere in between a monopoly (only one seller) and competition (many sellers). Firms are said to exhibit ‘strong mutual interdependence,’ meaning that an action by one firm is likely to have a substantial effect on the others. An example of this interdependence can be shown if firm A takes the action of lowering the price of its good. If other firms keep the same price as they had previously, they will lose sales to firm A. If they react by lowering their price to the same as that of firm A, they will avoid losing sales but will lose profit per sale equivalent to the fall in price that has occurred. To complicate things further, all other firms also have the option of cutting price below that of the firm A’s original cut. In oligopoly firms make their decisions on ‘some guess, or conjecture, about its competitors’ responses.’ Firms act on the predictions that they make but, due the complexities of the decisions that they face, firms often make the wrong choices. This guesswork leads to a complicated market. As a result, a number of models have been suggested, each attempting to explain the behavior of firms in oligopolistic competition. Important features of an oligopoly that need to be considered are firstly, whether the product is homogenous or differentiated, acting as a key determinant on level of advertising. Secondly, the influence on pricing behavior that arises through the presence of barriers to entry.
Augustin Cournot introduced one of the earliest models in 1838. He considered a ‘duopoly,’ an industry with two firms. These two firms produce homogenous products, allowing... [continues]
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