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In the Cournot model, each company assumes the output of the others, resulting in greater output than in a monopoly but less than in a state of perfect competition. This pushes prices lower but not as low as they would be in perfect competition. In the Bertrand model, the companies compete for the lowest possible price, resulting in perfect competition. Both models are applicable in different situations and times and neither expresses oligopoly perfectly. Less commonly, a third option is possible: if the companies in the oligopoly openly collude with each other, they can form a cartel.
oligopolya MARKET STRUCTURE characterized by concentrated supply conditions (i.e. a few large firms supply the bulk of industry output) and high barriers to entry. A key feature of oligopoly is the mutual interdependency of the leading suppliers, which has a major impact on the nature and intensity of their competitive relationships. For example, a price cut by one firm may seem advantageous as a unilateral act, but if rival suppliers are forced to follow suit rather than risk losing market share, such a move may escalate into a ‘price war’ leading to all firms suffering reduced profitability For this reason, oligopolists tend to prefer to coordinate their price behaviour (see PRICE LEADERSHIP, CARTEL, COLLUSION) and to seek instead to establish COMPETITIVE ADVANTAGE over rival suppliers through PRODUCT DIFFERENTIATION initiatives. See COMPETITION POLICY.
oligopolyA type of MARKET STRUCTURE that is characterized by:
- few firms and many buyers, that is, the bulk of market supply is in the hands of a relatively few large firms who sell to many small buyers.
- homogeneous or differentiated products, that is, the products offered by suppliers may be identical or, more commonly, differentiated from each other in one or more respects. These differences may be of a physical nature, involving functional features, or may be purely ‘imaginary’ in the sense that artificial differences are created through ADVERTISING and SALES PROMOTION (see PRODUCT DIFFERENTIATION).
- difficult market entry, that is, high BARRIERS TO ENTRY, which make it difficult for new firms to enter the market.
The primary characteristic associated with the condition of ‘fewness’ is known as MUTUAL INTERDEPENDENCE. Basically, each firm, when deciding upon its price and other market strategies, must explicitly take into account the likely reactions and countermoves of its competitors in response to its own moves. A price cut, for example, may appear to be advantageous to one firm considered in isolation, but if this results in other firms also cutting their prices to protect sales, then all firms may suffer reduced profits. Accordingly, oligopolists tend to avoid price competition, employing various mechanisms (PRICE LEADERSHIP, CARTELS) to coordinate their prices. See COLLUSION.
Oligopolists compete against each other using various product differentiation strategies (advertising and sales promotion, new product launches) because this preserves and enhances profitability -price cuts are easily matched whereas product differentiation is more difficult to duplicate, thereby offering the chance of a more permanent increase in market share; differentiation expands sales at existing prices or the extra costs involved can be ‘passed on’ to consumers; differentiation by developing brand loyalty to existing suppliers makes it difficult for new firms to enter the market.
Traditional (static) market theory shows oligopoly to result in a ‘MONOPOLY-like’ suboptimal MARKET PERFORMANCE: output is restricted to levels below cost minimization; inefficient firms are cushioned by a ‘reluctance’ to engage in price competition; differentiation competition increases supply costs; prices are set above minimum supply costs, yielding oligopolists ABOVE-NORMAL PROFITS that are protected by barriers to entry. As with monopoly, however, this analysis makes no allowance for the contribution that ECONOMIES OF SCALE may make to the reduction of industry costs and prices and the important contribution of oligopolistic competition to INNOVATION and NEW PRODUCT development. See KINKED-DEMAND CURVE, LIMIT-PRICING, PERFECT COMPETITION, MONOPOLISTIC COMPETITION, DUOPOLY, GAME THEORY, REVISED SEQUENCE, COMPETITION POLICY (UK).