TITLE – REAL WORLD EXAMPLES OF OLIGOPOLY &

THEIR FUNCTIONING.

              SUB TOPICS    PG NO.

SR.NO
   1 Introduction    1
      2  Theories of Oligopoly Market Structures        
   3  Real World Examples of Oligopoly
   4 Conclusion
5 References

INTRODUCTION 
The Oligopoly market structure is where, in which there are only few sellers who offer similar or
identical products. The market is imperfectly competitive market and it falls between the two
extremes i.e. between the perfect competition and monopoly.
The market having only few small groups of sellers a key feature of such kind of market is the
tension between them regarding co-operation and self-interest. This small group is best off co-
operating and acting like a monopolist - producing small amount of quantity of output and
charging price above marginal cost. The basic motive of each of the oligopolist is that, he cares
about his own profit, there are powerful incentives as well which hinders a group of firms
maintaining monopoly outcome. The simple type of oligopoly market situation where two
members are present is the case of duopoly. The Nash Equilibrium situation where participants
interacting with one another each choose their best strategy given the strategies that all others
have chosen.
Oligopolies are prevalent throughout the world and appear to be increasing ever so rapidly.
Unlike a monopoly, where one corporation dominates a certain market, an oligopoly consists of a
select few companies having significant influence over an industry. Oligopolies are noticeable in
a multitude of markets. While these companies are considered competitors within the specific
market, they tend to cooperate with each other to benefit as a whole, which can lead to higher
prices for consumers.

Theories of Oligopoly Market Structures

The central aim of market theories is to formulate predictions about firms' price and output
decisions in different situations, and, under such market forms as perfect competition and
monopoly, economists can be fairly certain about likely outcomes: in the case of the former,
price is set in the market through the free interaction of demand and supply, and individual firms
passively take this price and equate marginal cost with marginal revenue to determine the best
output; in the case of the latter, the firm will still equate MC with MR, but can restrict output and
raise price in so doing.
However, under oligopoly no such certainty exists - where the number of firms in the industry is
small and much interdependence exists between these firms, there will be a whole variety of
ways in which individual oligopolists may respond to rivals' price and output decisions.
Consequently, several different models of oligopoly have been developed, underpinned by
different analytical approaches and assumptions about the nature of oligopolistic, reactive market
behaviour. The various models of oligopoly can be classified under two main headings: non-
collusive or competitive oligopoly and collusive oligopoly.
1. Non-Collusive Oligopoly
In this case, each firm will embark upon a particular strategy without colluding with its rivals,
although there will of course still exist a state of interdependence, as possible reactions of rivals
will have to be considered. There are three broad approaches that might be adopted by firms in a
situation of competitive oligopoly:
 Observe the behaviour of rival firms but make no attempt to predict their possible
strategies on the basis that they will not develop counter strategies. This was the essence
of the earliest model of oligopoly developed by Cournot as far back as 1838: each firm
acts independently on the assumption that its decision will not provoke any response
from rivals; this is not generally accepted nowadays as providing a useful framework in
which to analyse contemporary oligopoly behaviour.
 Make the assumption that a given strategy will provoke a response from competitor
firms, and assess the nature of the response using past experience. This is the basis of the
kinked demand curve model, described below, in which it is assumed that any price cut
by one oligopolist will induce all others to do likewise, whilst a similar price increase
would not be matched.
 Formulate a strategy and try to anticipate how rivals are most likely to react, and be
prepared with suitable counter measures.
This is the basis of game theory in which competition under oligopoly is seen as being similar to
a game of chess in which every potential move must be regarded as a strategy, and possible
reactive moves by opponents and subsequent counter-moves must all be carefully considered.
The application of the theory of games to economics was first introduced in 1944 by J. von
Neuman and O. Morgenstern. Game theory involves the study of optimal strategies to maximise
payoffs, taking into account the risks involved in estimating reactions of opponents, and also the
conditions under which there is a unique solution, such that an optimum strategy for two
opponents is feasible and not inconsistent.
This theory of oligopoly was first developed in 1939 by Paul Sweezy in the U.S.A, and by R.
Hall and C. Hitch in the U.K, to explain why oligopolistic markets would be characterised by
relatively rigid prices, even when costs increase.
The kinked demand curve model makes the assumption of an asymmetrical reaction to a change
in price by one firm: a decrease in price by one firm will cause a similar reduction of price by
other firms eager to protect their market share, whilst a price increase by one firm will not be
matched and its market share will be eroded.

Here, the demand curve would be elastic and the change in price would again cause total revenue
to fall - OP3 x OQ3 is smaller than OP x OQ. The logical conclusion from this analysis would
therefore be that oligopolists would benefit from keeping prices stable so long as all could enjoy
reasonable profits at the established price.

The kinked demand curve theory also has other implications. A normal demand curve becomes
less elastic as price falls, but the oligopolist's demand curve becomes less elastic suddenly at the
kink. Mathematically, this causes the MR curve to suddenly change to a different position, so
that a discontinuity exists along the vertical line YZ above output OQ1.

This implies that the MC curve can increase or decrease between this discontiuity, without
necessitating a change in the profit maximising output OQ1 or price OP1 - the oligopolist will
absorb the higher costs. According to normal demand and supply analysis, an increase in costs
would cause a fall in output and an increase in price. An example of cost absorption in practice is
when the price of crude oil rises and petrol companies wish to increase price, but do not as no
company wants to be the first to do so.
2. Collusive Oligopoly
A central feature of competitive or non-collusive oligopoly is the existence of uncertainty
amongst the interdependent firms. Although these firms may utilise informed guesswork and
calculation to cope with such uncertainty, they can never be entirely sure as to how their
competitors will react to any given marketing strategy. Thus instead of living with uncertainty,
firms may adopt a policy of reducing, or even eliminating, it by some form of central co-
ordination, co-operation or collusion. Such collusion may occur where firms attempt to maximise
their joint profits, by reaching agreement on their price, output and other policies, or where firms
seek to prevent the entry of new firms into the industry so as to protect their longer run profits.
Formal Collusion
The most common type of formal collusion is through the cartel; where a small number of rival
firms, selling a similar product, come to the conclusion that it is in their joint interests to
formally collude rather than compete, they may establish a cartel arrangement in which they
agree to set an industry price and output which enables them to achieve a common objective.
This is likely to involve the setting of agreed output quotas for each member in order to maintain
the agreed price. A successful cartel arrangement, from the point of view of the participating
firms, would be one in which the cartel acts like a single monopolist to maximise profits of
individual members.

In practice, cartels may tend to be rather fragile and may not last for very long. This is because
individual members may have an incentive to renege on the agreement by secretly undercutting
the cartel price. The almost inevitable necessity to limit output to keep price high will tend to
leave individual firms with spare productive capacity, and provide the temptation to increase
profits by expanding output. Such an expansion would not only generate profit on the additional
sales, but would also increase the profits on existing sales, as average fixed costs would fall as
output expanded.
As the end result of successful collusion will be to create a situation similar to monopoly, with its
consequent drawbacks and loss of economic efficiency, cartels are illegal in many countries,
including the UK and the USA. Various cartels do, however, operate internationally, the most
famous of which is OPEC. Another example of an international cartel is IATA (The International
Air Transport Association) which has sought to set prices for international airline routes.
However, the experience of both these cartels has been one of price cutting amongst its
members, particularly during periods of declining product demand and competition from non-
members.
Informal Collusion
The most usual method of tacit collusion is priceleadership which occurs where one firm sets a
price which is subsequently accepted as the market price by the other producers. There need be
no formal or written agreement for this to happen; it is sufficient that firms believe this to be the
best way of maintaining or increasing their profits. Price leadership may take various forms:
 Dominant firm price leadership - This type of price leadership occurs where a firm,
probably by virtue of its size comes to dominate an industry in terms of its power to
influence market supply. The dominant firm sets a price to suit its own needs and the
smaller firms then adjust their planned output in line with the market price that has been
set for them. An example of such price leadership is provided by Ford Motor Company,
who have often been the first to raise prices in the car industry.
 Barometric price leadership - A barometric price leader need not necessarily be the
dominant firm in the industry; rather it will be a firm, possibly small in size, which is
acknowledged by others in the industry as having an informed insight into current market
conditions, perhaps because it employs the best team of accountants and market analysts.
The firm's reputation will therefore enable it to act as a 'barometer' to others in the
industry, and its price movements will be closely followed.
 Collusive price leadership - This involves a form of tacit group collusion in which
prices within an industry change almost simultaneously and is linked to price parallelism
where there are identical prices and price movements in a given market. In practice
collusive price leadership might be difficult to distinguish from dominant firm leadership,
especially in circumstances where the price leader is quickly followed.
Tacit collusion may also occur where firms in the industry follow a set of 'rules of thumb'
instead of a price leader. Such rules may be designed to prevent destructive competition
and thus maintain longer term profitability, although some short run profitability may be
sacrificed as the rules do not require MC and MR to be equated. One such rule of thumb
is cost-plus pricing.
 Cost-plus pricing - This is also known as average cost pricing, mark-up pricing and full-
cost pricing, and empirical evidence suggests that it is the most common pricing
procedure adopted by firms. It involves firms setting price by adding a standard
percentage profit margin to average costs, so that:
Price = AFC+ AVC + profit margin
Cost-plus pricing is consistent with the idea of relatively stable oligopoly prices as,
providing costs are stable, prices will also remain stable in the short run, even though
demand might be changing. Conversely, if costs rise on average by 5%, then prices in the
industry will also be rising by a similar percentage.

REAL WORLD EXAMPLES OF OLIGOPOLY- 

CASE – I : US automobile industry
The US automobile industry is a very good example of an oligopoly. It consists mainly of three
major firms, General Motors (GM), Ford, and Chrysler. The influence of this oligopoly can
be seen in the prices and the development and introduction of new car models into the American
car market. Extensive work has been done on the field of collusive behaviour in the US
automobile market and moreover the introduction of the small car in the 1950s shows how the
firms collude when it comes to the introduction of a new car.
This firm which is the price leader in the GM, Ford, and Chrysler oligopoly and how prices are
determined, in this there will be drawn a comparison between the surpluses and welfares in this
oligopoly and a perfect competition. Then analysis is why there cannot be found a Bertrand-Nash
Equilibrium. The oligopoly in the American automobile industry is collusive, because of that,
it will be pointed out how price cheaters are punished in that cartel. Finally, the underlying
decisions of an introduction of a new car model will be examined and the game theory will be
applied to that.
 The Price Leader in the Oligopoly
In the oligopoly of the American automobile industry a vivid dynamic between price leaders and
price followers can be found. Here is  the example of the pricing decisions between 1965 and
1971 shows strong evidence that General Motors is the price leader in this oligopoly (Boyle &
Hogarty, 1975). In this time span Chrysler always announced its price increases first, after that
General Motors announced a price increase which was smaller than Chrysler’s. General Motors’
move then led to Chrysler reducing its own price to be roughly the same as General Motors’
(Boyle & Hogarty, 1975). Boyle and Hogarty (1975) do not mention explicitly how Ford
behaved in that pricing arrangement but it can be assumed that Ford is a price follower who in
the end copies General Motors’ chosen price.
 How Prices are determined in US Automobile Industry
Now after having explained the relationships and the pricing behaviour in this cartel, the next
step is to show how the amounts of the prices are chosen. It is clear that there is a difference
between how prices are chosen in perfect competition markets and the oligopolistic market. In
perfect competitions the market participants can maximise their profit by producing the quantity
where the marginal costs of producing a unit is equal to the market price which itself is equal to
the marginal revenue. This yields to the fact that the market is efficient and competitive because
the market participant just charges the price where economic profit is zero. In contrast to that, the
collusive companies of General Motors, Ford, and Chrysler are trying to avoid this
competitiveness in the market by pricing jointly (Bresnahan, 1987). The oligopolists act like a
single monopolist when it comes to pricing decisions and want to maximise the joint profit
instead of the firm’s single profit (Bresnahan, 1987). This pricing decision leads to the result that
the collusive price is way above the marginal costs at this quantity, so maximising the profit of
the single companies to be as the maximised profit in the perfect competitive market (Bresnahan,
1987).
There was Wall Street Journal Report which published years much later in April 2005, the
global fights against cartels which highlighted the point that price fixing by cartels is illegal in
the most nations around the world.
 Influences on the Surpluses and Welfare
This collusive price setting behaviour leads, as usual in oligopolies or in this specific case of
oligopolists acting like one single monopolist, to a loss in total welfare and in the consumer
surplus. At the same time there is an increase in producer surplus because the price in the
collusive oligopoly acts like a mark-up on the price-quantity equation of equalising marginal
costs with marginal revenues. In figures, the collusive price generates a produce surplus of
$4billion in each year, while the loss of the consumers is $7billion in each year (Bresnahan,
1981). The total loss in welfare is over $3billion in each year (Bresnahan, 1981). These figures
show that there is a big loss in market efficiency after the introduction of the collusive price by
the oligopolists.

If one were to assess the Big Three, the takeaway would have to be that while General Motors is
bigger currently, Ford is healthier and bears the most potential to be the market leader in the
future & Chrysler is managing itself with other two industries. This, however, is secondary to the
fact that the American automotive industry is significantly stronger than it was ten years ago and
all three major players have taken steps to ensure this in the years to come and stay in the
Oligopoly Market.
Case II –

References
http://www.sanandres.esc.edu.ar/secondary/economics%20packs/microeconomics/page_124.htm
Stigler, G. (1964). A Theory of Oligopoly. Journal of Political Economy, 72(1), 44-61. Retrieved from
http://www.jstor.org/stable/1828791
https://core.ac.uk/download/pdf/10195316.pdf