What is an Oligopoly Market?
It is the market structure where there are few sellers (two or more), a limited (or given) market, and almost similar and very close substitute products. Due to the given size of the market, there is a significant interdependence, where the strategy of one firm directly affects the outcome of another. Therefore, there is an intense rivalry among the firms due to the given market size, which may lead to a level of cutthroat competition.
Based on the nature of the oligopoly market, it can broadly be classified into
- Collusive Oligopoly Market
- Cartel
- Joint Profit Maximizing Cartel (Syndicate)
- Market Sharing Cartel
- Market sharing by non-price competition
- Market sharing by quota or quantity
- Market sharing by specific area or product
- Price Leadership
- Low cost firm price leadership
- Dominant firm price leadership
- Barometric firm price leadership
- Cartel
- Non-collusive Oligopoly Market
In the collusive oligopoly, the firms voluntarily form a group in order to control the market outcome to favor them by minimizing the risk and uncertainty arising due to the given market. While in the non-collusive oligopoly, each firm competes individually using its best strategy under the assumption regarding the strategy of other firms.
1) Collusive Oligopoly
In this type of oligopoly market, there is a group of firms which name some agreements regarding the price, output or other strategies which the follow jointly. Such agreements are made to protect and promote their interest and avoid the risk and uncertainty of competing individually.
There are two types of collusion in the oligopoly market such as
- Cartel
- Price Leadership
1.Cartel
A cartel is the group of firms in the oligopoly market which makes the secret agreements regarding price or output or price & output both in order to protect and promote their common interest. This avoid the risk and uncertainty arising while competing individually. The agreement are tacit or secret because open cartel is illegal.
Types of Cartel
- Joint Profit Maximizing Cartel (Syndicate)
- Market Sharing Cartel
- Market sharing by non-price competition
- Market sharing by quota or quantity
- Market sharing by specific area or product
1. Joint profit maximizing cartel (Syndicate)
In this type of cartel, all the members firms of group select a central agency. The power of determining profit maximizing, price and output of the whole industry is given to the central agency. The central agency is also responsible to allocate such profit maximizing output to each of the member firm.
In this model. it is assumed that the central agency has the information about the market demand and marginal revenue of the market, It has all the information about the cost structure of each member firms. Then by horizontal summation of the marginal cost of member firms, the central agency estimate the marginal cost of the whole industry. Then by using the marginalist principle of profit maximization, central agency determines the price and output of the industry that maximized the joint profit.
After determining the profit maximizing output of the industry the central agency allocates this output to each of the member firm in such a way that the marginal cost of each firm equals to MC and MR of the industry as the equilibrium level of output.
In order to explain price and output determination under this model, assume that there are two firms A and B which agree to have a jount profit maximizing carteling.
Here,
the central agency has estimated the demand and marginal revenue of the industry as DI and MRI respectively. The marginal cost of the industry is computed as MCI = MCA + MCB
As the objective is to maximize the joint profit of the firms (industry profit), both conditions od profit maximization are satisfied at E* with P* price and OQ* quantity of industry.
Now, P* is the given price for both firms and central agency has allocated this profit maximizing output to firm A and firm B as OQA and OQB respectively so that OQA = OQB = OQX and MCA + MCB = MCI = MRI
The firm A is earning AREA a a` a“ P* profit and firm B is earning b b` b“ p* profit. So, the maximum joint profit of the industry is Area a a` a“ P* + b b` b“ p*
2. Market Sharing Cartel
In this type of cartel, all the member firms sit together to have a common strategy on the price and output in order to secure their interest and avoid risk and uncertainty of competing independently. All the firms equally participate to make a common decision regarding the price and output. There can be different forms of market sharing such as:
- Market sharing by non-price competition
- Market sharing by quota or fixed quantity
- Market sharing by product sector or geographical area
1. Market sharing by non-price competition
Under market sharing by non-price competition, all the firms agree to have a common price and they compete with each other using non-price strategy such as packaging, branding, marketing, texture, after sales service etc. The price is common for all the product and price is determined by the bargaining among the firms. In the bargaining, all the firms of the group participate equally where the high cost firms of may be bargaining for higher price and low cost firm bargains for lower price in order to sell more. The agreed price is such which gives at least some profit to all the member firms.
2.Market sharing by quota or quantity
In this type of market sharing, all the member firms of the group agree to have a fixed quota or quantity to supply in the market. Such quota is determined by the bargaining among them. While in bargaining for quota, the past sales history and supply capacity of the firm are considered. So, the firms agree to supply the fixed quantity or quota in the market. Such quota may be equal or unequal given the bargaining power of the firm. The price may be same of slightly different given the cost under the location of the firm.
3.Market sharing by specific product of location
In this type of market sharing, the firms agree to share the market by geographical area of specific products or sector. This is all determined by bargaining among the firms. The price may or may not be same given the differences in the cost of the production. The price and output determined by the bargaining should give at least some profit to all the involved firms.
Since there is no specific rules for determining the share of the market and the bargaining among the firm ultimately determines the market sharing strategy. In order to explain graphically, assume that there are two firms A and B which agree to have a market sharing cartel.
Here,
DA and DB are demand of the product for the firm A and B respectively, DM is the market demand
i.e DM = DA + DB
P* it the common price determined by bargaining which gives at least some profit to both firms. At the agree price P*, OQ* is the total quantity demand which is shared by the firm A and B respectively as OQA and OQB such that
OQA + OQB = OQ*
2. Price leadership model of oligopoly
In this type of collusive model, there is a firm in the group which is accepted as the leader by other firms. Being the leader of the group, the leader firm uses marginalistic criteria of profit maximization to determine its price and output and the rest of other firms follow the price set by the leader. The followers may not be maximizing their profit but in order to avoid risk and uncertainty in competing with the leader firm individually, they accept the price of the leader which give them at least some profit.
Types of leadership selection
- Low cost firm price leadership
- Dominant firm price leadership
- Barometric firm price leadership
1.Low cost firm price leadership
In this model of price leadership, the firm with the lowest cost in the industry is accepted as the leader by high cost firms. So, the low cost firm (leader) uses the marginalistic principle of profit maximization or to determine its own profit maximizing price and quantity. Then the high cost firm follow the price by the leader which may not be profit maximizing to them but gives at least some level of profit to all.
In order to explain price and output determination under this model, assume that there are two firms A and B with respective demand and marginal revenue as DA, DB and MRA and MRB.
They agree to have low cost price leadership model to determine the price and output.
Here, MCA < MCB, the firm A is the low cost firm. So, firm A is leader and B is follower.
The firm A, being the leader determines its own profit maximizing price and output where both conditions of profit maximization of the firm A are satisfied at EA.