Effect of Oligopoly on Economy

Topics: Oligopoly, Economics, Cartel Pages: 6 (1541 words) Published: October 12, 2008

In this topic the oligopoly form of market is studied. You will learn that fewness of firms in a market results in mutual
interdependence. The fear of price wars is verified with the help of the kinked demand curve. Collusive forms and
non-collusive forms of market are analyzed. The economic effect of the oligopoly form of market is presented.

The oligopoly form of market is characterized by
- a few large dominant firms, with many small ones,
- a product either standardized or differentiated,
- power of dominant firms over price, but fear of retaliation, - technological or economic barriers to become a dominant firm, - extensive use of nonprice competition because of the fear of price wars.

All "big" business is in the oligopoly form of market. Being a major corporation almost automatically implies that the company has means of controlling its market.

An oligopoly form of market is characterized by the presence of a few dominant firms. There may be a large number of small
firms, but only the major firm have the power to retaliate. This results in a high concentration of the industry in only 2 to 10 firms with large market shares.

The gasoline industry is an oligopoly in the United States: it is dominated by a few giant firms such as Exxon, Mobil, Chevron and Texaco. Note, however, that many small firms exist in the
market: small independent gas stations which sell in just one city or just a limited region.

The most notable causes for the high concentration in oligopoly type of markets are
- economies of scale present in production of certain goods, - business cycles eliminating weak competitors,
- benefits from firms merging, and
- other barriers such as technological development and

The history of the U.S. automobile manufacturing shows a
continuous process of increasing concentration of the market in the hands of the big 3: G.M., Ford and Chrysler. Not long ago, Chrysler acquired the failing American Motors. In the beginning of this century, a new round of concentration is now taking place on a global scale as Daimler acquired Chrysler, Renault acquired Honda and GM seeks to acquire Daewoo. The needed volume of production to be profitable (100,000 vehicles) is a major barrier for any new firm wishing to start producing cars.

The demand of a firm in oligopoly is made of two segments of two separate demand curves. The upper part is highly elastic
because if the firm raises its price, the other firms will not follow, and the firm will lose its market share. The lower part is inelastic because if the firm lowers its price, the other firms follow, and no firm can expand its market share.

Graph G-MIC7.1

Several gas stations are often found next to each other at major highway intersections. They also often have same or similar
prices. If one gas station tries to increase its price from the prevailing 125.9 to 127.9, customers will go across the street and the gas station will lose revenues. If the same gas station lowers is price to 123.9, it will attract new customers only until the other also drop their prices; then all will lose


The lesson from the kinked demand is that a strategy of
increasing its price will cause a firm to lose revenue, but so will decreasing price. Thus, firms will tend not to change
prices. Furthermore, as a result of the kinked demand curve, marginal revenue has a gap or break, and any marginal cost
curve would lead to the same optimum quantity. Thus the same price is optimum for many different cost structures.

All firms benefit from avoiding price wars and seeking to
agree on higher prices and protected sale volumes. These
agreements are generally illegal. Thus, secret agreements
are sought: these constitute collusion.

All businesses...
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