American Business



An oligopoly is a MARKET STRUCTURE in which there are BARRIERS TO ENTRY, allowing for only a few firms. Oligopolies occur in those industries in which it is difficult for new competitors to get established. CAPITAL, technology, or LICENSING frequently restricts entry into oligopolistic markets, which can have either standardized or differentiated PRODUCTs. The critical characteristic of oligopolies is that there are only a few competitors in the market. Because of this, the actions of each individual firm usually affect the other firms in the market. This creates what economists call MUTUAL INTERDEPENDENCE. In competitive markets there are many small firms, so if one firm lowers its price or increases its output, it has virtually no impact on the overall market conditions. But in an oligopoly, because each firm is a significant part of the industry output, if one firm lowers its price, its actions affect the DEMAND for the other oligopolists’ products. If one oligopolist lowers its price below the existing market price and the other firms do not match that price decrease, the one firm will see an increase in sales and the other oligopolists will lose sales. But business managers do not like to lose their share of the market, so logically the other firms in the industry will match the one oligopolist’s price decrease. Conversely, if one oligopolist raises its price, the other firms will be happy to take away new customers from that firm. This interdependence creates what is known as a kinked-demand curve, whereby oligopolists will match a price decrease but will not usually follow a price increase. The result of market independence is price rigidity. It usually does not benefit an oligopolist to compete on a price basis. Mutual interdependence among the few firms in an oligopoly is overcome by a variety of methods, some legal and some illegal in the United States. Recognizing that competing on a price basis will not benefit them, oligopolists frequently compete on a nonprice basis. A classic example of this is found in the cereal industry. Examination of the cereal aisle in grocery stores and supermarkets will show that four companies—Kellogg, Post, General Mills, and Quaker Oats—produce almost all of the choices, and their prices are amazingly similar. These four competitors attempt to increase their sales and PROFITs through PRODUCT PROLIFERATION. Another legal way for oligopolists to compete is through price leadership. One firm announces a price change, and the other firms quickly match the leading firm’s actions. Occasionally the other oligopolists will not match the leading firm’s price change, and usually a few days later the firm will rescind that price. The U.S. airline industry and banking industry frequently use this method of changing prices. In the 1990s, one airline began a practice of signaling price changes in advance to the few competing firms on specific routes. The competitors would then signal whether they would also increase their price. This procedure, called collusion, is illegal in the United States. The U.S. automobile-manufacturing industry is often cited as an example of an oligopoly. Each year (usually in August) manufacturers announce their price changes for the new model year; invariably the prices are very similar. Automobile manufacturers compete primarily on a basis of product differentiation such as image, safety features, environmental- control devices, and having the largest or most fuel-efficient models. Near the end of the model year, manufacturers begin to compete on a price basis, offering rebates and below-cost financing to sell existing inventory before the new model year begins. When the prices for the new models are announced, they are once again amazingly similar.