Table of Contents
Oligopoly is a market condition whereby the industry is dominated by small number of firms. The existence of a smaller number of firms generally leads to a low level of competition resulting in higher prices. The products in an oligopolistic market condition are either similar or differentiated. Firms are aware of each others’ actions. The decisions taken by a single firm in an oligopoly market structure usually affects the decisions of other competing firms. This gives rise to a wide range of outcomes in the market. Either, restrictive trade practices like collusions or market sharing are employed in any oligopolistic structure. Firms undertake to collude in a bid to stabilize the market and reduce risks anticipated. Oligopolies can engage in competitions by lowering prices and encouraging higher productions. Such strategies are aimed at raising the general price levels and to restrict production by competing firms. Agreements of collaboration are used to control the operations of firms in the oligopoly market structure and are called cartels.
Oil producing companies have employed the strategy of collusion to operate in the oil market. The most notable cartel in the oil industry is OPEC. It sets and influences the international oil prices. Oligopolies have a strong incentive to collude as this will enable them work closely to restrict the level of output. It ensures that the firms earn a profit that is desirable to all of them. Individual oligopoly firms can engage in malpractices as individual firm’s demand curve is more elastic than the overall market demand curve. They can decide to lower prices in a bid to sell to the customers who would otherwise not buy at high prices. They can also use this strategy to attract new customers from competing firms.
Oligopoly firms tend to maximize their profits by producing in the conditions where their marginal revenue equals marginal costs. This can be illustrated with the help of a profit maximization curve.
From the figure above, firms operating under oligopoly will be forced to produce at intersection PbQb or PaQa. The LRATC curve is the marginal cost curve while the MR curve is the marginal revenue curve. If a firm under oligopoly increases its prices from Pb toPa, the amount of products consumed will reduce from Qb to Qa. This will be as a result of costumers shifting to firms that would otherwise have not changed their prices. To stabilize the situation, competing firms that will be experiencing increased levels of demand on their products will follow suit by increasing their prices to ease the pressure of excessive demand. Either, a firm that decides to reduce its prices from Pa to Pb will experience increased sales as consumers will rush for their products. Their quantity of sale will therefore shift from Qa to Qb.
There are factors that affect the level of competition between firms in an oligopoly market structure. These factors have a wide range of effects and can generally be categorized as discussed in the next page.
Low entry barriers
The level of restriction to entry in an oligopolistic market structure is low. New firms will most likely be attracted to the market by the new economic profits that may exist. This situation may worsen as the control on the firm’s operations may not be possible. A good example is when the OPEC group of oil producing countries decided to raise the oil prices in the late 1970’s. This made the non OPEC countries to increase their production. This they did to contend with the increased demand on their products that were deemed cheap. OPEC lost a significant portion of its market shared due to their higher prices. Their reaction was a reduction in the prices of their products in an attempt to regain their market share that they had lost.
Countries and governments can formulate legislations regulating business practices. Legislations such as antitrust law can be formulated to rein in on the operations of business organizations. Antitrust laws are laws that prohibit collusions. This will greatly affect the business practices in markets associated with oligopoly. Some business owners may be forced to make secret business agreements that may not be enforceable in the courts.
Unstable demand conditions
Many business organizations under oligopoly do engage in business dealings. When there exists conditions of unstable demand patterns, collusions become difficult to undertake. Firms may differ on the direction perceived to be best for the industry. They may not agree on a common path to follow. The highly ambitious firms may expect an increase in the general levels of demand in the market. This will result in them increasing their levels of output. Those who are a bit reserved and laid back will employ the wait and see strategy. They will argue that the demand levels would most likely remain the same. This will be influenced by their interpretation of the prevailing unstable conditions. Thus, they will stick to their production schedules and maintain their level of output. These posses a great challenge in case the differing business organizations were to engage in collusion.
Increasing number of firms
When the number of firms engaged in a similar line of business increase, there ability to form agreements and collude in the business is significantly affected. Bureaucratic processes will crop in making it difficult to discus, negotiate and enforce agreements. The industry in the long run will become competitive market.
There are a number of strategies that can be used by firms to set their prices in an oligopoly. Firms can either decide to collude and form cartels that they will use to set a market price that is agreeable to all of them. Either, industries can identify and acknowledge a firm as a price leader. The leader will informally set the market prices that the firms will adopt.
In conclusion, therefore, oligopoly is majorly applied in international business by firms operating on an international platform. To maximize their profits, firms operating under oligopoly market conditions must devise appropriate strategy to set their prices. The use of cartels will most likely be advantageous hence should be adopted by oligopolistic firms.