Concentration and interdependence: what marks out an oligopoly

Overview

Oligopolists spend heavily on monitoring what their rivals are doing, uncertainty tend to make oligopolists cautious about changing price and supernormal profit persist in oligopoly in the long run.

What you need to know

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Questions from this subtopic

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1. 1

   What is an oligopoly?

   Model answer

   An oligopoly is a market structure in which a small number of large firms supply most of the output, so that each firm holds a share big enough for its own decisions to have a noticeable effect on its rivals. It is identified by the concentration of market share rather than by an exact head-count of firms.

2. 2

   Why is interdependence, rather than simply having few sellers, the defining feature of oligopoly?

   Model answer

   Interdependence means each firm's profit depends not only on its own price and output but on how rivals respond to them. In perfect competition or monopolistic competition a single firm is too small for anyone to notice, and a pure monopolist has no rival to notice it; only in oligopoly must a firm form an expectation of a rival's reaction before it acts.

3. 3

   How is a concentration ratio calculated, and what does a five-firm concentration ratio of 82 per cent tell you?

   Model answer

   A concentration ratio adds the market shares of the largest firms in an industry. A five-firm ratio of 82 per cent means the five biggest firms between them supply 82 per cent of sales, leaving 18 per cent to everyone else, which is strong evidence of an oligopoly.

4. 4

   Two industries both have a three-firm concentration ratio of 75 per cent. In the first the shares are 25, 25 and 25; in the second they are 60, 10 and 5. Why might these behave very differently?

   Model answer

   The first looks like a contest between three equals, where interdependence is symmetric and each firm watches the other two closely. The second contains a dominant firm with 60 per cent, which is far more likely to act as a price leader while the smaller firms follow, so the concentration ratio alone conceals an important difference in strategic position.

5. 5

   Why can a firm in oligopoly not be said to have a supply curve in the way a perfectly competitive firm can?

   Model answer

   A supply curve maps each price to the quantity a firm would willingly produce, which requires the firm to take price as given. An oligopolist chooses its price and its output together, and the quantity it will sell at any price depends on what rivals do, so no single stable price-quantity relationship exists.

6. 6

   Is the product in an oligopoly homogeneous or differentiated?

   Model answer

   It can be either. Petrol, cement and industrial gases are close to homogeneous oligopolies, while cars, soft drinks, mobile phone contracts and breakfast cereals are differentiated oligopolies. Differentiation matters because it changes which weapons of competition are available to the firms.

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