Oligopoly

By Rajat Mehla (2910017)

 Oligopoly:-

Introduction 

An oligopoly is a market form in which a market or industry is dominated by a small number of sellers [citation needed] Because there are few sellers, each oligopolist is likely to be aware of the (oligopolists)actions of the others. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by oligopolists needs to take into account the likely responses of the other market participants.

                                                            OR

The word OLIGOPOLY is derived from the Greek word oligos which means few

Oligopolistic Market is a market characterized by a small number of producers who often act together to control the supply of a particular good and its market price.

It is dominated by a few large suppliers who are interdependent on each other, before making any pricing and investment decisions. It is also explained as a market condition in which sellers are so few that an action of any one of them will materially affect price and have a measurable impact on competitors; in other words; since there are few participants in this type of market, each Oligopolist is aware of the actions of the other.

(OPEC is an example of Oligopoly since few countries control the production of oil, the steel and the automobile industry in United States of America is another example. )

Description:-

Oligopoly is a common market form. As a quantitative description of oligopoly, the four-firm concentration ratio is often utilized. This measure expresses the market share of the four largest firms in an industry as a percentage. For example, as of fourth quarter 2008, Verizon, AT&T, Sprint, Nextel, and T-Mobile together control 89% of the US cellular phone market.

Oligopolistic competition can give rise to a wide range of different outcomes. In some situations, thefirms may employ restrictive trade practices (collusion, market sharing etc.) to raise prices and restrict production in much the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a cartel. A primary example of such a cartel is OPEC which has a profound influence on the international price of oil.

Firms often collude in an attempt to stabilize unstable markets, so as to reduce the risks inherent in these markets for investment and product development.[citation needed] There are legal restrictions on such collusion in most countries. There does not have to be a formal agreement for collusion to take place (although for the act to be illegal there must be actual communication between companies)–for example, in some industries there may be an acknowledged market leader which informally sets prices to which other producers respond, known as price leadership.

In other situations, competition between sellers in an oligopoly can be fierce, with relatively low prices and high production. This could lead to an efficient outcome approaching perfect competition. The competition in an oligopoly can be greater when there are more firms in an industry than if, for example, the firms were only regionally based and did not compete directly with each other. Thus the welfare analysis of oligopolies is sensitive to the parameter values used to define the market's structure. In particular, the level of dead weight loss is hard to measure. The study of product differentiation indicates that oligopolies might also create excessive levels of differentiation in order to stifle competition.An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists).[citation needed] Because there are few sellers, each oligopolist is likely to be aware of the actions of the others. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by oligopolists needs to take into account the likely responses of the other market participants.

Characteristics:-

ð  Profit maximisation conditions: An oligopoly maximises profits by producing where marginal revenue equals marginal costs.

ð  Ability to set price: Oligopolies are price setters rather than price takers.

ð  Entry and exit: Barriers to entry are high.[2] The most important barriers are economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy nascent firms. Additional sources of barriers to entry often result from government regulation favoring existing firms making it difficult for new firms to enter the market.

ð  Number of firms: "Few" – a "handful" of sellers.[2] There are so few firms that the actions of one firm can influence the actions of the other firms.

ð  Long run profits: Oligopolies can retain long run abnormal profits. High barriers of entry prevent sideline firms from entering market to capture excess profits.

ð  Product differentiation: Product may be homogeneous (steel) or differentiated (automobiles).[3]

ð  Perfect knowledge: Assumptions about perfect knowledge vary but the knowledge of various economic actors can be generally described as selective. Oligopolies have perfect knowledge of their own cost and demand functions but their inter-firm information may be incomplete. Buyers have only imperfect knowledge as to price,[2] cost and product quality.

ð  Interdependence: The distinctive feature of an oligopoly is interdependence.[5] Oligopolies are typically composed of a few large firms. Each firm is so large that its actions affect market conditions. Therefore the competing firms will be aware of a firm's market actions and will respond appropriately. This means that in contemplating a market action, a firm must take into consideration the possible reactions of all competing firms and the firm's countermoves.[6] It is very much like a game of chess or pool in which a player must anticipate a whole sequence of moves and countermoves in determining how to achieve his objectives. For example, an oligopoly considering a price reduction may wish to estimate the likelihood that competing firms would also lower their prices and possibly trigger a ruinous price war. Or if the firm is considering a price increase, it may want to know whether other firms will also increase prices or hold existing prices constant. This high degree of interdependence and need to be aware of what the other guy is doing or might do is to be contrasted with lack of interdependence in other market structures. In a PC market there is zero interdependence because no firm is large enough to affect market price. All firms in a PC market are price takers, information which they robotically follow in maximizing profits. In a monopoly there are no competitors to be concerned about. In a monopolistically competitive market each firm's effects on market conditions is so negligible as to be safely ignored by competitors.

In simplewords  its characteristics are:

Ø  It is a market dominated by a small number of participants who are able to collectively exert control over supply and market prices.

Ø  Few firms sell branded products which are close substitutes of each other.

Ø  Entry barriers for the other firms are high; the barriers can be due to patents, copyrights, government rules / regulations or ownership of scare resources.

Ø  Firms are interdependent for decision making.

Ø  Products can be homogenous (standardized) or heterogeneous (differentiated).

Ø  The sellers are the price makers and not price takers, since the few sellers mutually dominate the pricing decisions.

Ø  The sellers can achieve supernormal profits in the long run.

Ø  The sellers can achieve economies of scale; since for the large producers as the level of production rises, the cost per unit of products decreases; thus ensuring higher profits.

Ø  There is high degree of market concentration, since the four-firm concentration ratio is often used, where the market shares of four largest firms are measured (as a percentage) since they form the major portion of the market share.

Examples of oligopoly:-

ð  India’s Banking Sector is highly profitable earnings very high Lending Deposit Spreads.India’s Central Bank RBI has said that this spread (NIM) needs to come down in order for India to grow by double digits.However the Banks are in no mood to change their highly profitable business model.With India’s Economy growing at a rapid pace the banks are seeing high credit growth and net interest income as well.They are opposed to any change in the status quo which allows them to make supernormal profits in the highly regulated banking sector.Note I am calling the Financial Sector as an Oligopoly because the Central Bank strictly controls the entry of new players in the Banking Sector.RBI has recently proposed giving new banking licenses to some more companies but it won’t change the structure of the industry.

ð  If there is one fuel that has the potential to prime India’s economic growth in the future, it is natural gas. An estimated 37 trillion cu. ft of reserves available can power the country for considerably longer than its oil resources. This, however, is dependent on the presence a right policy framework. If indications are anything, the government has botched our fuel future.

For any scarce resource, proper allocation can only occur through well-regulated markets. This happens when such a resource follows price signals. Distort the prices and you’ve ensured sub-par economic performance. In the case of natural gas, India is an oligopoly with two big players in the exploration and production (E&P) space and another two big players in the downstream, transmission and distribution (T&D) sector. The government, instead of striving for a more reasonable market structure, has abetted the creation of this oligopoly. It is not only a question of indulging in corrupt practices to favour one player over another, but that of a mindset that favours oligopoly. In such a situation, price discovery is impossible and price distortion a certainty.

Consider the facts. On the E&P side, just two contractors, Oil and Natural Gas Corp. Ltd (ONGC) and Reliance Industries Ltd (RIL), have won 62% of the exploration blocks that represent 79% of the acreage auctioned so far. ONGC has 59 fields and 397,000 sq. km and RIL 33 fields and 341,000 sq. km. In the T&D sector, again, there are only two significant players, Gas Authority of India Ltd (GAIL) and its subsidiary GAIL Gas Ltd and RIL and its subsidiary Reliance Gas Ltd. It does not matter if ONGC and GAIL are government-owned and RIL is a private entity: The market structure makes nonsense of price discovery.

What is alarming, however, is the fact that RIL is a vertically integrated entity: it is a big player in both E&P and T&D spaces. Even more alarming is the fact that the downstream sector regulator, the Petroleum and Natural Gas Regulatory Board has inspired no confidence in managing this problem. Unlike regulators in other sectors, it has little role in price regulation.

Here it is important to stress how the government’s mindset of “scarcity economics”, something recently highlighted by chairman of the 13th Finance Commission Vijay Kelkar, has contributed to the mess. The government has a list of sectors it wants to allocate gas on priority. Fertilizer and power generation top this list. It has had to reserve natural gas for these sectors because they are in no position to pay spot-market determined prices as government controls their output prices. Thus the government reasons that if you cannot pay the market price, the commodity must be scarce. That is the road to oligopoly and inefficiency and not the path to prosperity.

ð  Indian Telecommunication industry, with about 464.82 million phone connections (June 2009), is the third largest telecommunication network in the world and the second largest in terms of number of wireless connections. For the past decade or so, telecommunication activities have gained momentum in India. The Indian Telecommunication Market has been dominated by few major players, and hence it is a perfect case of Oligopoly.