Oligopoly- Definition, Classification, and Characteristics

What is Oligopoly?

The term ‘Oligopoly’ is derived from two Greek Words “Oligoi” meaning a few and “pollein” meaning to sell. Oligopoly is that form of imperfect competition where there are a few firms in the market, producing either a homogeneous product or producing products that are close but not perfect substitutes of each other. Oligopoly differs from monopoly where there is only one seller, and from perfect and monopolistic competition where there are many sellers. Oligopoly is also sometimes referred to as limited competition, incomplete monopoly, multiple monopoly, etc. Several of the present-day markets in capitalist countries are oligopolistic. The prices and outputs of several important products, such as steel, aluminum, automobiles, tyres, heavy electrical equipment, etc., are determined by a few firms in each of the industries that produce them.

Classification of Oligopoly:

Oligopoly can be classified on different bases:

(1) Oligopoly is classified as Perfect (or, Pure) Oligopoly and Imperfect (or, Differentiated) Oligopoly on the basis of product differentiation. Oligopoly is perfect or pure if the product produced by the competing firms is homogeneous or identical. On the other hand, an oligopoly is imperfect or differentiated when the competing firms produce products that are close but not perfect substitutes.

(2) Oligopoly may be classified as Open Oligopoly and Closed Oligopoly on the basis of freedom to enter the industry. An open oligopoly refers to a market situation where new firms are free to enter the industry. A closed oligopoly, on the other hand, is a market situation where the new firms are not allowed free entry into the industry.

(3) Oligopoly may be classified into Collusive Oligopoly and Non-collusive Oligopoly on the basis of agreement or understanding among the firms. A collusive oligopoly refers to a market situation where the firms, instead of competing, combine together to fix the prices and outputs of the industry. A non-collusive oligopoly implies a lack of any understanding or agreement among the firms.

(4) Oligopoly is also sometimes classified as Partial Oligopoly and Full Oligopoly on the basis of the presence or absence of price leadership. Partial Oligopoly refers to a market situation where the industry is dominated by one large firm which is looked upon as the price leader. The rest of the small firms look to the price leader for lead in fixing the prices of their products. A full oligopoly, on the contrary, is a situation where price leadership is conspicuous by its absence.

(5) Oligopoly may also be classified into Syndicated Oligopoly and Organized Oligopoly on the basis of the degree of coordination to be found among the firms. The former refers to that situation where the firms sell their products through a centralized syndicate. The latter refers to that situation where the firms organized themselves into a central association for fixing prices, outputs, quotas, etc.

Characteristics of Oligopoly:

We should carefully study these special characteristics because they will have an important bearing on price and output determination under an oligopoly.

(1) Interdependence- Under perfect competition, there is no question of interdependence of firms. There are so many small-sized firms operating in the market that none of them is in a position to affect the price or output of the industry in any significant manner. No firm, therefore, bothers about the actions or reactions of the other firms. Under monopoly also, the question of the interdependence of firms does not arise, because there is one single firm in the market and it does not care about the reactions of other rival firms to its price-output policies, because their products are at best only very distant substitutes for its own product.

But this attitude is not possible under an oligopoly. As pointed out earlier, there are only a few firms in the market, each producing a homogeneous or slightly differentiated product. Since the number of firms is small, each firm enjoys a large share of the market and is in a position to influence the price and output of the industry in a significant manner. No firm can, therefore, fail to take into account the reactions of the other firms to its price and output policies. There is, therefore, a good deal of interdependence of the firms under an oligopoly. This can be illustrated by means of an example. Let us suppose that there are four firms ‘A’, ‘B’, ‘C’, and ‘D’ operating in an industry, approximately of an equal size and producing a homogeneous product. Firm ‘A’, let us suppose, desires to increase its sales (and also its share of the market) by reducing its price. But before enforcing the price cut, Firm ‘A’ will take into account the possible reactions of firms ‘B’, ‘C’, and ‘D’ to its policy. It will cut the price only if it is sure that firms ‘B’, ‘C’, and ‘D’ will not retaliate by cutting down the prices of their products. It is quite possible that firms ‘B’, ‘C’, and ‘D’ might resent the price cut by Firm ‘A’, but do nothing else to give concrete shape to their resentment. But it is also possible that these firms might decide to reduce the prices of their products by an amount equal to, less than, or greater than the original reduction by Firm ‘A’. The price policies adopted by these three firms will have an important effect on the sales of Firm ‘A’. So Firm ‘A’ cannot afford to be indifferent to the reactions of the other firms to its own price policy. Then, it is quite possible that Firm ‘A’ might not resort to price-cutting as such, but might, on the other hand, vary the quality of its product or spend an increased amount on advertisement, etc., to push up its sales. Even in that case, it will have to take into account the reaction of its rivals. What it implies is that Firm ‘A’ cannot take any independent action in the spheres of price, quality, or sales promotion, without taking into account the possible reactions of the other competing firms.

(2) Indeterminateness of Demand Curve- This characteristic is actually the direct result of the first characteristic of oligopoly discussed above. The mutual interdependence of firms creates an atmosphere of uncertainty for all firms. No firm under an oligopoly is in a position to visualize the consequences of its price-output policy with any degree of certainty. It cannot, for example, make an estimate of what its sales would be if it were to cut down the price of its product by a certain percentage. Hence its demand or revenue curve is indeterminate. The demand curve, as is well-known, relates to the various quantities of the product that could be sold at different levels of prices. When the quantity to be sold at a particular level is itself uncertain, the demand curve cannot obviously be definite, determinate, and certain. This situation is in sharp contrast with that existing under either perfect competition or monopoly. The firm under perfect competition has a determinate demand or average revenue curve, which is a horizontal line at the level determined by the market price. The firm can have no independent price policy nor does it have a product policy of its own, since the product is homogeneous. As such, the demand curve of the firm is determinate. Likewise, the firm under monopoly also has a definite and determinate demand curve, because it fixes the price of its product itself without worrying about the reaction of its rivals, if any. The firm is, thus, in a position to visualize its sales with a certain amount of certainty and definiteness. Hence its demand curve is determinate.

But, as pointed out above, the demand curve of an oligopolistic firm, by its very nature, cannot be determinate or definite, because the firm in question cannot predict the reactions of its rivals to its price-output policy. For example, if the firm cuts down the price of its product, it is not sure whether the other firms will retaliate by cutting down the prices of their products. It is possible that the other firms may not reduce their prices or if they reduce their prices, they may not reduce them to the same extent. As such, the demand or average revenue curve of the firm concerned cannot be definite or determinate. The truth is that a firm under oligopoly may not have a single determinate demand (or, average revenue) curve, but rather a family of such curves, each curve being based on one possibility. In Diagrams (A) and (B) below, we have indicated two such possibilities.

Oligopoly Diagram

In Diagram (A), the curve DD (or, AR) represents a situation in which the rival firms do not change the prices of their products in response to the change in price made by the firm in question. The curve D’D’ (or, A’R’) reflects a situation where the price change introduced by the firm in question is also duplicated by the rival firms. You can note for yourself how different is the curve D’D’ (A’R’) from the curve DD (AR). The curveD’D’ (A’R’) is much less elastic than the curve DD (AR). There are many other possible demand curves, depending on the exact nature of the reactions of the rival firms. One popular demand curve is based on the assumption that price reductions are usually matched by rival firms, but price increases remain more or less unmatched. The kinky demand curve D”D” (A”R”) shown in Diagram (B) represents this situation. This curve is, in fact, a combination of the two curves in the Diagram (A)- DD (AR) curve to the left of the P and D’D’ (A’R’) curve to its right. We, thus, find that the shape and the slope of the demand curve of an oligopolistic firm are uncertain and indefinite. This uncertainty of the shape and the slope of the demand curve under oligopoly conditions greatly complicates the pricing problem of the firm. No firm is in a position to fix the price of its product independently without taking into account the reactions of its rivals.

(3) Conflicting Attitudes of Firms- A peculiarity of oligopoly is the existence of two conflicting attitudes on the part of the firms operating in the market. At times, the firms realize the disadvantages of mutual competition and desire to combine or unite together to maximize their joint profits. The tendency among the various firms at such times is towards collusion to serve their common interests. At other times, the desire of each firm to earn maximum profits may initiate conflict and antagonism among the oligopoly firms. Instead of cooperating with each other, they might come into a clash on the questions of distribution of profits and allocation of markets. So two conflicting trends are at work under oligopoly- one of cooperation and united action and the other of conflict and antagonism. The two trends may alternate with each other under oligopoly conditions. This is an additional factor leading to the creation of an atmosphere of uncertainty under an oligopoly.

(4) Element of Monopoly- There is an element of monopoly present in oligopolistic conditions. As pointed out earlier, there are only a few firms in the markets under differentiated oligopoly; each firm producing a differentiated product. Since each firm controls a large share of the market and produces a differentiated product, it acts in its own limited sphere as a petty monopolist when it comes to price and output fixation. The element of monopoly becomes still more conspicuous when the customers are deeply attached to the product of the oligopolistic firm. In that case, the firm will have greater freedom to fix price and output at the desired level.

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