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Business Economics Firms tend to have very tricky behavior in oligopolistic industries. Oligopoly is a market structure dominated by a small number of large firms, selling either identical or differentiated products, and there are significant barriers to entry into the industry. This is one of four basic market structures. The other three are perfect competition, monopoly, and monopolistic competition. Oligopoly being a general market structure category, dominates the modern economic landscape. About half of the output produced in the worlds economy can be traced to oligopolistic industries.
Oligopolistic industries are as diverse as they are widespread. Oligopoly ranges from breakfast cereal to cars, from computers to aircrafts, from television broadcasting to pharmaceuticals, from petroleum to detergent. Because each firm in an oligopolistic industry is relatively large, each has a substantial degree of market control. Its not total control like in a situation of monopoly, but its significantly greater than that of a monopolistic ally competitive firm. While monopolistic competition and oligopoly have distinct identifiable characteristics, they really form a continuum on the spectrum of market structures. Any boundary separating oligopoly from monopolistic competition is fuzzy at beast.
An industry that's monopolistic ally competitive in a large city, for example, might be oligopolistic in a smaller town. A key feature of oligopoly is interdependence among firms in an industry. The actions of one firm depend on the actions of another. In both perfect competition and monopolistic competition the actions of one firm have no affect on other firms. Each firm is so small relative to the overall market, that firms are independent. And of course monopoly is the only firm in an industry, so interdependence is not a relevant issue.
Oligopolistic interdependence creates a number of interesting economic issues. One is the tendency for competing oligopolistic firms to turn into cooperating oligopolistic firms. When they do, inefficiency worsens, and they tend to come under the scrutiny of government antitrust laws. Alternatively, oligopolistic firms tend to be a prime source of innovations, innovations that promote technological advances and economic growth. Oligopoly exists when there are a small number of firms selling in a single market. The usual reason for this situation is that the optimal size of firm, the size at which average cost is minimized, is so large that there is only room for a few such firms.
The situation differs from perfect competition because each firm is large enough to have a significant effect on the market price. It differs from monopoly because there is more than one firm. It differs from monopolistic competition because the firms are few enough and their products similar enough that each must take account of the behavior of all the others. The number of firms may be fixed, or it may be free to vary.
So far as their customers are concerned, oligopolies have no more need to worry about strategic behavior than do monopolies. The problem is with their competitors. All of the firms will be better off if they keep their output down and their prices up. But each individual firm is then better off increasing its output in order to take advantage of the high price.
One can imagine at least three different outcomes. The firms might get together and form a cartel, coordinating their behavior as if they were a single monopoly. They might behave independently, each trying to maximize its own profit while somehow taking account of the effect of what it does on what the other firms do. Finally, and perhaps least plausibly, the firms might decide to ignore their ability to affect price, perhaps on the theory that in the long run any price above average cost would pull in competitors, and behave as if they were in a competitive market. Internet business fads come and go with remarkable speeds. The imminent demise of the latest hot trend: online procurement marketplaces created by industry consortia.
Over the last few months, Heavy-hitters in industries ranging from autos to aerospace to agriculture have announced such marketplaces, also known as online exchanges. A recent example of firms joining forces is the latest entry, named Transport, links consumer product giants such as Coca-Cola, General Mills (GIS), Kraft Foods, Procter & Gamble and Unilever in one of the most ambitious online exchanges to date, It isnt hard to see the basic logic of these ventures. By joining forces, companies gain the critical mass needed for effective online marketplaces, while at the same time barring the door to upstart dot-coms that are building their own exchanges. The result, they hope, will be far greater efficiencies in purchasing supplies of all kinds and a means of taking advantage of the Internet without altering the established balance of power in their industries. While normally one thinks of national or global industries when oligopolies are conversed about. There are also local oligopolies.
If a city only has two commercial bakeries or three radio stations these firms would enjoy economic power stemming from market share, although their small absolute size might not be much of a barrier to potential competitors. Oligopolistic firms that operate on a national or global scale are also huge in another sense they are just plain big. Many have several hundred thousand employees and multi-billions of dollars in assets. Size is itself a source of power. Size provides protection against potential competition remember that ease of entry is one of the factors by which we measure competition.
Very few of us could raise the $ 8 billion or so that it takes to start an automobile firm. And such size makes it easier avoid a forced exit. There were over 100 automobile firms in the U. S. in 1929. Of the eight firms that survived the Great Depression, seven had been the seven largest in 1929.
The three surviving U. S. automobile firms today are the same firms that were the three largest in the 1920 s. Strategic Alliances and Partial Ownership sometimes occurs in the business world. Large firms often have ownership or other working relationships with other large firms and many smaller firms in the same industry.
Ford, for example, owns Jaguar, half of Aston Martin, 25 % of Mazda, and 10 % of Kia. Ford also has technology-sharing agreements with Fiat and Nissan. General Motors and Toyota jointly own and operate an auto plant in California. More recently, Motorola joined the strategic alliance formed earlier by IBM, Siemens and Toshiba to jointly develop the next generation of memory chips. Since Motorola lagged behind these firms in research, it paid several million dollars to the leading firms for access to their chip-design research. Toshiba and IBM have a separate agreement for computer-screen technology and will jointly operate a flat-screen factory in Virginia.
In many parts of Europe, cartels were legal. Firms in the same line of business would enter into a formal - and enforceable - agreement to limit production and thus maintain high prices. But both arrangements - trusts and cartels - brought business stability (and profits) at the cost of high consumer prices, limited new investment (in order to limit production) and a diminution of the type of competition that drives firms to develop new products and new production processes. Oligopolies as the formation of trusts was restricted in the United States and cartels came under greater regulation in Europe, the oligopoly became the predominant big-business structure. With four or five large firms responsible for most of the output of each industry, avoidance of price competition became almost automatic. If one firm were to lower its prices, it is likely that its competitors will do the same and all will suffer lower profits.
On the other hand, it is dangerous for any single firm to increase its prices since the others might hold their prices in order to gain market share. The safest thing is to never lower prices and only raises prices when there is abundant evidence that the other firms will also raise prices. The largest or lowest-cost or most aggressive firm will often emerge as the price leader. When business conditions permit, the price leader will raise prices with the expectation that the others will follow. The practice of price leadership prevails in many industries: Automobiles, breakfast cereals, beer, steel and bank loans are among the many goods and services that are usually priced in this manner.
On the surface, it looks as though the effect of price leadership is the same as the effect of the fixing of prices by a cartel or a trust. But there is a fundamental difference. The trust or cartel assigns production quotas to its members in order to keep production down. Competition does not exist in any form. Oligopolies that follow a price leader do not engage in price competition, but they still contest for market share with a variety of forms of non-price competition. Pepsi and Coke each spend billions on TV ads designed to entice the consumer to switch cola brands, but those expensive ads never mention price.
The approach adopted by the critics is basically one of analyzing the outcomes and trade implications of the behavior of firms operating in conditions which fall short of the ideals of perfect competition (monopolistic competition, imperfect competition, increasing returns to scale). Much of the literature in this category represents sympathetic attempts to relax the basic assumptions of the H-O model and test its robustness (Kierzkowski, 1987). In this context, monopolistic competition and other forms of imperfect competition have come to be central to the literature on trade theory largely reflecting the persistence of intra-industry trade in reality. At one extreme there are those who equate countries to single firms, analyse their oligopolistic interactions, and attempt to link the instruments and concepts of industrial organization with the general equilibrium model (Caves, 1980; Brander, 1981; Brander and Krugman, 1983). Other analyses have tried to formalize equilibrium trade patterns, with endogenous technological change and monopolistic competition as the innovative intermediate inputs (Ethier, 1979; Krugman, 1987; Grossman and Helpman, 1989, 1990 a). (Kotler) The link between trade theory and industrial organization was first proposed simultaneously by Dixit and Norman (1980), Krugman (1979) and Lancaster (1980). (Kotler) It has even been suggested that it is the contribution by Dixit and Stiglitz (1977) and Lancaster (1979) () that provided the foundations for a theoretical framework for analysing economies of scale and product differentiation in a general equilibrium setting (Greenway, 1991).
Since then, developments in this area have taken two directions: modeling the role of economies of scale and analyzing market structures. In the latter case various forms of imperfect competition are taken as a starting point and the possibilities of strategic behavior and interactions between firms are treated in the analysis. Economies of scale have recently come to be seen as more important (e. g. Scherer, 1980). Various explanations for this trend have been given in the literature (e.
g. Helpman and Krugman, 1985; Alberta, 1994). First, where industries produce multiple products, many products may be produced at less than optimal scale. Second, there may be important economies of multi-product operation, which are not captured by plant-based estimates of scale economies. Third, there may be important dynamic scale economies internal to firms.
The existence of economies of scale provides an incentive for international specialization and trade. This incentive may complement the explanatory power of differences in factor proportions, and may even give rise to trade in the absence of such differences (Helpman and Krugman, 1985). Except under special circumstances, a world of increasing returns to scale will not be a world of perfectly competitive markets. However, in the absence of a generally accepted theory of imperfect competition, the admission of economies of scale would make it difficult to generalize on trade. More specifically, the presence of economies of scale implies that the H-O model can guarantee neither gains from trade nor the existence and uniqueness of free trade equilibrium. The problem is that the persistent presence of economies of scale is inherently inconsistent with competitive equilibrium, as marginal cost pricing would in that case imply losses.
Thus the admission of economies of scale calls for an analysis based on a market structure that allows prices above marginal cost. It is in this context that more explicit consideration has been given to alternative market structures in the analysis of international trade. The analysis of trade issues in the context of a variety of market structures has explored several issues, which could not have been addressed adequately in the framework of the perfectly competitive model. The most notable approaches to the analysis of various market structures include: trade policy and the power of domestic firms, the role of price discrimination and dumping, and the role of governments in giving domestic firms a competitive advantage. Another group of analysts raise questions of the implications of the link between market structures and trade theories for new arguments for protectionism. Further extensions along these lines have attempted to capture more complex insights such as the role of intermediate goods (Ethier, 1982), non-traded goods (Helpman and Krugman, 1985), market size effects (Krugman, 1980; Helpman and Krugman, 1985) and attempts to demonstrate that economies of scope and / or vertical integration lead to the emergence of multi-activity firms such as multinational corporations (Helpman and Krugman, 1985).
The literature within this strand has basically examined alternative theories of market structures, which deviate from perfect competition (Helpman and Krugman, 1985). Such analyses assumed various kinds of imperfectly competitive market structures such as contestable markets (Baumol et al. , 1982), Cournot oligopoly and monopolistic competition. () Two main strands can be identified here: those assuming various forms of Chamberlinian monopolistic competition and those analyzing various forms of oligopoly. Various models based on Chamberlinian monopolistic competition have been developed, mainly analysing the interaction between economies of scale, product differentiation and different forms of monopolistic competition (Krugman, 1987). These models have demonstrated welfare gains from increased product variety and from lower prices. Essentially, however, the insights of the H-O model are shown to hold quite well under conditions of product differentiation and such economies of scale. The question, which the analysts of various forms of oligopoly have asked, is whether firms with market power act in a cooperative or non-cooperative manner.
Since formal cartel and price-fixing arrangements are generally not legal, such cooperation arrangements are to a large extent tacit. Partly for this reason, the theory of cooperative behavior in oligopolistic industries is not well developed. Most of the contributors on this subject have therefore restricted their analysis of markets to non-cooperative behavior. The outcome of non-cooperative behavior by firms has largely depended on the strategic variables with which the game is played and the conditions of entry into and exit from the industry.
Most theoretical work on oligopoly has tended to take as the strategic variable either outputs (the Cournot assumption) or prices (the Brand assumption). In more general terms, various forms of market imperfection permit firms to earn returns exceeding those that are tenable in purely competitive industries, suggesting that trade policy can be used to influence the share of international profits accruing to domestic firms (and in that way to the economy). For instance, subsidies can be used to shift profits in favor of domestic firms, implying enhancement of their strategic position versus foreign rivals in competition for world markets. Oligopoly is a situation in which few firms dominate the industry. Oligopolies should have at least three different outcomes.
Them being, the firms might get together and form a cartel, coordinating their behavior as if they were a single monopoly. They might behave independently, each trying to maximize its own profit while somehow taking account of the effect of what it does on what the other firms do. Oligopoly is a crucial market structure, and to my belief it is being the most integral. Consequently it is possible to state that really firms behavior in oligopolistic industry depends largely on the circumstances that the business is involved in.
And thus it is not always possible to predict what is going to happen in any particular business operation. Bibliography: Berger, A. A. (2000). Oligopolistic Development. Lanham: Rowan & Littlefeild Publishers, Inc. Berry, J. , Guber, S.
S. (1993). Firms Behavior in Oligopoly. New York: McGraw-Hill, Inc. Kent, F. H. Stone, E.
C. (1984). Legal and Business Aspects of the Advertising Industry 1984. New York: Practicing Law Institute. Are, N. , Munger, J. , Purdy, W. (1999, Fall). Gender Issues in Oligopoly. Women and Language, v 22 i 2, p 20.
Retrieved March 30, 2001 from InfoTrac database (Expanded Academic ASAP) on the World Wide Web Richards, J. I. (2000). Philip Kotler, Marketing Management, New York: Viking Press, 1999 Has, Alexander, et al. , Marketing for Dummies (IDG Books. 1997) Kotler, Philip, Kotler on Marketing (Free Press 1999). Lamb, Charles W. , et al. , Essentials of Marketing (South-Western 1998). Lehmann, Ronald R. , and Russell S. Winer, Analysis for Marketing Planning, 4 th ed. (Irwin 1996).
McNamee, Patrick B. , Strategic Market Planning: A Blueprint for Success (Wiley 1998). Strauss, Judy, and Raymond Frost, Marketing on the Internet (Prentice Hall 1999). Tell, Gerard J. , Advertising and Sales Promotion Strategy (Addison-Wesley 1997).
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