A small number of market structures are commonly present in countries around the world. In Topic 5, we focused on the monopolistic competition, and now we will look at the oligopoly market structure.
In very simple terms, an oligopoly is a market comprised of a particular combination of a few powerful suppliers that offer very similar products or services. They determine their strategy based on how each firm may act and how each supplier's behaviour individually and collectively will affect the market.
Price and market share are key elements that the suppliers are constantly considering. As you can imagine, it is a dynamic flow. If prices for products sold go up for all firms, then all firms may make a greater profit. Alternatively, firms may consider lowering their price and aim to gain a greater market share. However, with a few similar firms, such as telephone companies, one supplier acts to lower the price, all suppliers may lower their price, and therefore all firms have lowered their profits. So, they are less likely to do that over the longer term.
The consideration of oligopoly markets moves well beyond microeconomics and has macroeconomic impacts. For example, with only a few large domestic airlines or supermarkets in a country, the efficiencies, prices and supply in an oligopoly market has macroeconomic impacts. For example, if all the airlines in a country set lower-tier fares, then demand for flights will increase, and economic activity will expand. Governments worldwide, particularly in Australia and the United States, take an interest in promoting competition. Anything they may see as reducing competition, such as oligopoly firms acting together and all raising prices, may attract sanctions under the law.
Welcome to Topic 6: Oligopoly. In this topic, you will learn about:
- Oligopoly markets and competition
- Characteristics of an oligopoly market
- Advantages and disadvantages of oligopoly market
- Oligopolies evolve over time.
These relate to Subject Learning Outcomes:
- Interpret economic models, diagrams and tables to describe the economic situations.
- Explain how government policy influences microeconomic choices and macroeconomic outcomes.
- Analyse the economy as a whole using macroeconomic models.
Welcome to your pre-seminar learning tasks for this week. Please ensure you complete these prior to attending your scheduled seminar with your lecturer.
Click on each of the following headings to read more about what is required for each of your pre-seminar learning tasks.
Read Chapter 17 of the prescribed text – Mankiw, NG 2016, Principles of microeconomics, 8th edn, Cengage Learning Custom Publishing.
Complete Worksheet 1 and save this file to your reflective journal.
You can access the reflective journal by clicking on ‘Journal’ in the navigation bar for this subject.
Read the article by Sprague, L 2019, Why the Airbus-Boeing duopoly dominate 99% of the large plane market, CNBC, and watch the included video.
Take note that this video was recorded in January 2019, before the impact of the COVID-19 pandemic on travel.
Task: In your reflective journal, identify two (2) positive impacts of the duopoly and two (2) negative impacts of the duopoly.
Complete the following tasks:
- Watch Investopedia 2021, Prisoner’s dilemma, Investopedia.
- Read the section Prisoner’s dilemma from OpenStax 2016, Principles of economics, Pressbooks.
You will now have learnt about the concept of prisoner’s dilemma, a scenario in which the gains from cooperation are larger than rewards from pursuing self-interest. This concept underpins the behaviour of firms in an oligopoly as they weigh up individual company gain versus overall levels of profit in the short and longer term.
Task: In your reflective journal, identify two (2) examples of firms in a particular industry that meet the following criteria:
- Intending to exercise market power
- Affect price and profit
- Are acting in a way that is conscious of their similar competitors.
Read and watch the following content.
Oligopoly markets and competition
Oligopoly is the second most common market structure behind the monopolistic competition. When oligopolies result from taking advantage of economies of scale to produce at a low average cost, they may benefit consumers considerably. Oligopoly markets often have some protection by the presence of very significant barriers to entry, enabling sustained profits over longer periods of time for the oligopolists. It also means that they do not generally produce at the minimum of their average cost curves. In addition, Oligopolists may lack the incentives to deliver innovative products and high-quality service when there is a lack of competition (Mankiw 2016).
In many economies, but not all, it is public policy to sustain healthy competition to encourage efficiency and consumer influence through free choice. However, these economies are attempting to promote competitive behaviour beneficial to the broader society. This can be achieved through laws by seeking to discourage behaviour that only adds to the profits of a few large companies, with no corresponding benefit to consumers (Greenlaw & Shapiro 2017).
So, what is duopoly? If only two (2) firms are dominating a competitive market, it is termed a duopoly.
For example, Qantas and Virgin are the two (2) firms dominating the competitive domestic airlines market in Australia, in addition, before Aldi arrived to the supermarket market, both Woolworths and Coles dominated this area and were a duopoly. Moreover, another duopoly is in the passenger aircraft market with Boeing and Airbus.
Key concepts of oligopoly competition
The following key terms are often used in the context of an oligopoly.
Collusion
Collusion is an agreement among firms in a market about what quantities to produce or what prices to charge. It may be between two firms or many firms. Such an agreement is most likely concealed for consumers (McConnell 1960).
Cartel
A cartel is an agreement on the distribution of production. The Organization of the Petroleum Exporting Countries (OPEC) is perhaps the best-known cartel and, in some respects, the most powerful oligopoly because oil is an input into production for so many industries and firms. However, this may change over the long term as renewable energy sources become more widely adopted worldwide, including solar, wind and hydropower production.
Barriers to entry
The longevity and size of a firm in a market may give rise to natural economic barriers to entry if it becomes too expensive for new firms to invest enough capital to gain profitable market share. Economic, legal and technological factors can contribute to the formation and maintenance or dissolution of oligopolies.
For example, in Australia, we see the big four (4) banks increasingly challenged by fintech – financial technology – pay later services, cryptocurrencies, new credit facilities and other means of exchange and finance other than bank-based savings, loans and transactions. In Australia, the big four banks are effectively an oligopoly. However, small, non-traditional banks are growing and merging with other small financial institutions, just as app-based payment fintechs innovate and increasingly offer substitute services to many traditional banking services.
Learning task 1: OPEC Cartel
- Read the Energy Education article, OPEC (Cartel).
- In your reflective journal, identify the types of conduct possible in a cartel that would lead to an inefficient allocation of resources or lead to customers paying more than would otherwise.
Learning task 2: Fintech
- Read the article, Macquarie suggests tech threatens $70b in big bank revenue, by Richardson, T 2021.
- In your reflective journal, identify the key takeouts on defensive tactics to maintain control and market share for the banks as new competitors emerge.
- Then, list the different fintech apps you have used instead of a bank in the last two (2) years.
Characteristics of an oligopoly market
Now that we know the basic definition of a competitive oligopoly, let us look a little deeper and define some main characteristics of this type of market. Boyce (2021) lists the following are six (6) key characteristics of a competitive oligopoly:
- A few firms with large market share
- High barriers to entry
- Interdependence
- Each firm has little market power in its own right
- Higher prices than perfect competition
- More efficient.
Examples oligopoly markets
Let us look at some examples of oligopoly markets. Click on each of the following headings to learn more about each example.
According to Boyce (2001), “Anheuser-Busch InBev, SABMiller, Heineken International, and Carlsberg Group own over 70 % of the global beer market”.
This type of market creates barriers to enter the industry for outside competition. Due to barriers like patents and government restrictions, it can be difficult for other firms to enter the market.
The top four (4) firms own a combined 98 % of the total wireless network market (Boyce 2001). These firms include:
- Verizon
- Sprint
- AT&T
- T-Mobile.
To better understand oligopoly competition in Australia, read the article, Minifie of Grattan Institute.
Advantages and disadvantages of oligopoly market
The strategic approach of planning pricing and supply based on predicting what competitors will do is a key concept in oligopoly markets. There is the general view in oligopoly markets that if any one of the suppliers lowers prices, then other suppliers will also lower prices. This will effectively keep about the same sales market share but at a lower profit margin.
A key feature of oligopoly market competition is the tension between cooperation and self-interest. The natural inclination of firms is to outmanoeuvre other competitors and increase market share. However, as we can observe, firms in an oligopoly soon realise the greater profit margins, the better marginal revenue over marginal cost. The small number of firms in an oligopoly are better off cooperating and effectively acting as a monopoly by controlling supply and setting prices above their marginal cost. Customers can often observe this. Legal regulators can too and may penalise the firms in countries were acting in a way that deliberately reduces competition is illegal, as it is in Australia (Dean et al. 2017).
When a firm in an oligopoly individually chooses to increase production to maximise profit, it produces a quantity of output greater than the level produced by a monopoly and less than the level produced in a competitive market. We understand from elasticity that demand increases and prices rise in some markets where supply is contained. In some instances, this can be a deliberate sales promotion tactic, where a firm will suggest limited qualities of a particular product to deliberately create higher short-term demand and change a higher price. The overall existence of an oligopoly and the ability of firms to control supply, influence price and do so collectively to enhance their collective profit is where it becomes anti-competitive and often illegal. The following figure illustrates how market concentration and market control changes as an oligopoly is closer to a monopoly.
Oligopolies evolve over time
An oligopoly market may evolve over time as competition between many firms drives out inefficient firms, and some larger firms take over smaller firms, reducing the total number of firms. This has occurred over many decades in many industries. In some cases, it may be that the conditions when older companies were established, such as before World War I and World War II or the post-war industrial boom, created conditions that do not exist today.
Some firms starting today can see larger older competitors have had decades to build huge capitals and infrastructure resources. Any sector that requires economies of scale to be efficient and profitable, such as airlines, may be far more difficult to enter than a new market that needs little capital, such as a new app-based e-commerce business. So, we see hundreds of new apps launched every day, but hardly any new airlines have been created, and the established firms are getting a larger market share.
Of course, there are many examples of firms that grew very large and became inefficient in how they competed and differentiated their products. In some cases, cheaper, better alternatives came along and took their market share. A prominent example of this is Kodak. They missed the differentiation and technology shift to digital photography and are today considered a failure (Mui 2012). Read the article, How Kodak failed to learn more.
A key to competing for new firms can be on the strength of their differentiation, as we looked at with the previous topic monopolistic competition. For example, the growth in air travel is not with international travel but in space travel, which is a very different market!
Knowledge check
Complete the following task.
Key takeouts
Congratulations, we made it to the end of the sixth topic! Some key takeouts from Topic 6:
- An oligopoly market is less competitive than monopolistic competition but more competitive than a monopoly.
- A cartel is where a few suppliers collaborate to enable them to act with monopoly-like power in influencing a market.
- Any type of market or conduct in a market by suppliers that are anti-competitive or reduces competition generally leads to inefficient allocation of resources and/or higher prices for consumers.
- In many countries, any market conduct that is aimed to reduce competition may be illegal. However, an oligopoly is not automatically illegal and may occur due to barriers to entry, such as the sheer scale of investment required in establishing a new supplier in a market.
Welcome to your seminar for this topic. Your lecturer will start a video stream during your scheduled class time. You can access your scheduled class by clicking on ‘Live Sessions’ found within your navigation bar and locating the relevant day/class or by clicking on the following link and then clicking ‘Join’ to enter the class.
Click here to access your seminar.
The learning tasks are listed below. These will be completed during the seminar with your lecturer. Should you be unable to attend, you will be able to watch the recording, which can be found via the following link or by navigating to the class through ‘Live Sessions’ via your navigation bar.
Click here to access the recording. (Please note: this will be available shortly after the live session has ended.)
The in-seminar learning tasks identified will be completed during the scheduled seminar. Your lecturer will guide you through these tasks. Click on each of the following headings to read more about the requirements for each of your in-seminar learning tasks.
In breakout rooms assigned by your lecturer, complete the following task:
Identify two (2) current industry markets that you could start up a new business and enter as a new firm. The following criteria must be met:
- Identify one (1) such market that is a monopolistic competition market.
- Identify one (1) such market that is an oligopoly market.
Discuss why your group has chosen these markets and what it is about the market conditions and competition that would support an efficient allocation of resources (with supply, price and demand factors considered) to sustain profitability.
Your lecturer will provide feedback from Assessment 1. Please bring any questions you may have.
Welcome to your post-seminar learning tasks for this week. Please ensure you complete these after attending your scheduled seminar with your lecturer. Your lecturer will advise you if any of these are to be completed during your consultation session. Click on each of the following headings to read more about the requirements for each of your post-seminar learning tasks.
Read the following case study:
Alemson, MA 1970, ‘Advertising and the nature of competition in oligopoly over time: A case study’, The Economic Journal, 80(318):282-306.
It is important to reflect on monopolistic competition and oligopoly and reinforce your understanding of these topics together.
Review Topic 5: Monopolistic competition and Topic 6: Oligopoly. In your reflective journal, identify a minimum of 10 key takeouts.
In your reflective journal, write the answers to the following two (2) questions:
- Identify a specific industry that is a monopolistic competition market and identify three (3) advantages to the consumer because of the nature of the market.
- Identify a specific industry that is an oligopoly market and identify three (3) advantages to the consumer because of the nature of the market.
Use this time to start preparing your Assessment Two (2) draft.
Each week you will have a consultation session, which will be facilitated by your lecturer. You can join in and work with your peers on activities relating to this subject. These session times and activities will be communicated to you by your lecturer each week. Your lecturer will start a video stream during your scheduled class time. You can access your scheduled class by clicking on ‘Live Sessions’ found within your navigation bar and locating the relevant day/class or by clicking on the following link and then clicking 'Join' to enter the class.
Click here to access your consultation session.
Should you be unable to attend, you will be able to watch the recording, which can be found via the following link or by navigating to the class through ‘Live Sessions’ via your navigation bar.
Click here to access the recording. (Please note: this will be available shortly after the live session has ended.)
- Caves, RE & Porter, ME 1978, ‘Market structure, oligopoly, and stability of market shares’, The Journal of Industrial Economics, 26(4), 289–313.
- Mazzeo, MJ 2002, ‘Product choice and oligopoly market structure’, The RAND Journal of Economics, 33(2), 221–242.
References
- Australian Consumer and Competition Commission 2011, Cartel conduct – how it affects you and your business, ACCC, https://www.accc.gov.au/system/files/Cartel%20conduct%20how%20it%20affects%20your%20business.pdf
- Alemson, MA, 1970 'Advertising and the nature of competition in oligopoly over time: A case study', The Economic Journal, 80(318):282–306.
- Boyce, P 2021, Oligopoly definition, Boycewire, https://boycewire.com/oligopoly-definition/
- Dean, E, Elardo, J, Green, M, Wilson, B & Berger, S 2017, Principles of microeconomics - scarcity and social provisioning, Open Oregon Educational Resources.
- Donev, LGJG 2020, OPEC (Cartel), Energy Education, https://energyeducation.ca/encyclopedia/OPEC_(cartel)
- Greenlaw, SA & Shapiro, D 2017, Principles of economics 2e, 2nd edn., OpenStax, https://openstax.org/books/principles-economics-2e/pages/10-1-monopolistic-competition
- Investopedia 2021, Prisoner’s dilemma, Investopedia, https://www.investopedia.com/terms/p/prisoners-dilemma.asp
- Mankiw, NG 2016, Principles of microeconomics, 8th edn., Cengage Learning Custom Publishing.
- McConnell, CR, Brue, S & Flynn, S 2011, Economics: Principles, problems, and policies, 18th edn., McGraw-Hill.
- Minifie, J 2017, Why oligopolies are not dominating Australian consumers, GRATTAN Institute https://grattan.edu.au/news/why-oligopolies-are-not-dominating-australian-consumers/
- Mui, C 2012, How Kodak Failed, Forbes, https://www.forbes.com/sites/chunkamui/2012/01/18/how-kodak-failed/?sh=7c2a222a6f27
- OpenStax, 2016 Prisoner’s dilemma, Principles of economics, Pressbooks, https://opentextbc.ca/principlesofeconomics/chapter/10-2-oligopoly/
- Richardson, T 2021, Macquarie suggests tech threatens $70b in big bank revenue, Financial Review, https://www.afr.com/markets/equity-markets/macquarie-suggests-tech-threat-could-crush-big-four-banks-revenues-20211011-p58yxw
- Sprague, K 2019, Why the Airbus-Boeing duopoly dominate 99% of the large plane market, CNBC, https://www.cnbc.com/2019/01/25/why-the-airbus-boeing-companies-dominate-99percent-of-the-large-plane-market.html
