CHAPTER 21: Oligopoly
Three main characteristics of an oligopolistic market:’
1.Few firms in the market
2.Dominance of large firms
3.Product differentiation
4.Barriers to entry
5.Collusion
6. Non-Price Competition
7. Price Competition
Case Study: The Global Motor Industry The global motor
industry is a prime example of an oligopoly, dominated by six
major firms:
•Toyota
•Volkswagen
•General Motors (GM)
•Renault-Nissan
•Hyundai
•Ford
1. Few Firms in the Market
•One of the defining features of an oligopoly is the presence of a limited
number of firms.
•There is no fixed number, but it typically ranges from three to six major
players.
•A classic example is the music entertainment industry, where three
companies—Universal Music Group, Sony BMG, and Warner Music Group—
dominate the global market.
•Due to the small number of firms, competition is restricted, leading to
unique market behaviors such as price stability and strategic decision-making.
2. Large Firms Dominate
•In an oligopoly, a few large firms hold a significant share of the market.
•These firms influence industry trends, set prices, and establish market norms.
•For example, in the automobile industry, the 'Big Six' car manufacturers control about 70% of the global
market.
•Smaller firms in the market often follow the pricing strategies of dominant firms rather than setting
their own prices.
•This market dominance often results in reduced price competition and can lead to higher profits for the
largest firms.
3. Product Differentiation
•Although firms in an oligopoly sell similar products, they differentiate their products to attract different
market segments.
•For example, in the automobile industry, companies offer variations in style, size, shape, interior design,
colors, performance, and technology.
•Even within the same industry, firms make efforts to ensure their products stand out through branding
and unique features.
•This differentiation allows firms to maintain customer loyalty and reduce direct price competition.
•While products in an oligopolistic market may be similar, firms actively
differentiate them to attract different customer segments.
•In the automobile industry, manufacturers offer variations in:
•Style
•Size
•Shape
•Interior design
•Colors
•Performance
•Specifications and quality
•Firms use branding, advertising, and product design to create distinctions from
competitors.
•This differentiation helps firms maintain customer loyalty and reduce direct price
competition
4. Barriers to Entry
•Large firms in an oligopoly benefit from high barriers to entry, making it
difficult for new firms to enter the market.
•Common barriers include:
• High setup costs (e.g., automobile manufacturing requires substantial
capital investment).
• Strong brand loyalty (established firms invest heavily in marketing to
discourage new entrants).
• Economies of scale (large firms can produce at lower costs, making it
hard for new firms to compete).
•Without these barriers, high profits in the industry would attract new
competitors, reducing the dominance of existing firms.
5. Collusion
•In some oligopolistic markets, firms may engage in collusion, where they form agreements to
restrict competition.
•Types of collusion:
• Market sharing: Firms divide geographical regions to avoid competition.
• Price fixing: All firms agree to charge the same higher price.
• Output restriction: Firms agree to limit production, reducing supply and increasing prices.
•Collusion is illegal in many countries because it exploits consumers by keeping prices artificially
high.
6. Non-Price Competition
•Since firms in an oligopoly prefer to avoid price wars, they compete using non-price strategies,
such as:
• Advertising and branding (creating strong brand loyalty).
• Promotions like coupons, loyalty cards, and competitions.
• Product differentiation (even when differences are minor or imagined).
•Example: The difference between a Mars Bar and a Cadbury Flake is real, but the difference
between Kellogg’s Cornflakes and a generic supermarket brand is often a result of branding rather
than significant quality differences
7. Price Competition
•Prices in oligopolistic markets tend to remain stable for long periods.
•The market leader often sets the price, and others follow.
•Price wars occur when one firm lowers its price, forcing competitors to
follow, leading to lower profits for all firms.
•Firms in an oligopoly are interdependent:
• If one firm reduces its price, others must follow or risk losing market
share.
• Instead of lowering prices, firms often respond by improving
promotions or advertising to maintain their market position.
Advantages of Oligopoly
1. Choice in Oligopolistic Markets
•Competition ensures that consumers have a variety of options.
•Product Differentiation: Oligopolistic firms often introduce new brands to
provide consumers with fresh choices.
•Niche Markets: Small producers can compete by catering to specific market
segments.
• Example: In the car industry, Morgan Cars (UK) operates in a niche market
catering to luxury sports cars.
•Limitations of Choice:
• In some industries, such as fuel markets, a few large firms dominate,
offering little real choice.
• Example: The petrol industry, where differences between suppliers may be
minimal.
2. Quality as a Competitive Advantage
•Non-Price Competition: Since price wars are rare, firms compete by
improving product quality.
•Perceived Superiority: Companies may claim their products are of superior
quality to attract customers.
• Example: The U.S. soft drink industry, where major players (Coca-Cola,
PepsiCo, Dr. Pepper Snapple Group) compete based on taste and
branding.
•Market Positioning:
• Firms gain market power by differentiating their products, making them
more desirable to consumers.
•The perceived quality of a product might not always reflect actual quality.
•Consumers may believe a product is better due to strong advertising and
promotional strategies rather than real differences in quality.
•This is particularly evident in industries like fashion, luxury goods, and electronics.
•Firms gain market power by differentiating their products, making them more
desirable to consumers.
3. Economies of Scale
•As firms grow larger, they reduce costs by producing more efficiently.
•Consumer Benefit: Some of the cost savings may be passed down in the form of lower
prices.
•Small Firm Survival: Smaller firms often survive by targeting niche markets instead of
directly competing with dominant firms.
4. Innovation in Oligopolistic Markets
•Potential for High Innovation: Large firms have the resources to invest in Research &
Development (R&D).
• Example: Car manufacturers developing new models to outperform competitors.
•Challenges to Innovation:
• Heavy spending on advertising and branding might divert resources from true
innovation.
• Consumer perceptions of quality may be shaped more by marketing than by actual
product improvements.
5. Price Wars
•Stable Pricing: Prices in oligopolistic markets tend to remain steady over long periods,
providing certainty for consumers.
•Occasional Price Wars:
• When one firm lowers prices aggressively, others must follow to maintain market
share.
• Consumers benefit in the short run from lower prices.
•Long-Term Consequences:
• Price wars can force weaker firms out of the market.
• Reduced competition may eventually lead to higher prices.
• Example: UK Supermarket Price War (2017) – Morrison’s reduced prices on 800
products to remain competitive.
Disadvantages of oligopoly :
1.Collusion Among Firms – Firms may collude to restrict competition,
leading to practices like price fixing. This results in higher prices for
consumers.
2.Higher Prices – When firms agree on price fixing, consumers end up
paying more than they would in a competitive market.
3.Limited Consumer Choice – If the market is divided geographically among
firms, only one firm will supply each area, reducing options for consumers.
4.Market Manipulation – Firms can control supply and pricing, as seen in
the Colgate-Palmolive case, which negatively affects market fairness and
competition.
5.Illegal Cartels – In some cases, firms form cartels, which function like
monopolies. Cartels are illegal in many regions (e.g., USA and EU) because
they eliminate competition and exploit consumers.
•Supply Restrictions – Firms or cartels, like oil-producing countries, may
intentionally restrict supply to force prices higher. This harms consumers by
making essential goods more expensive.
•Risk of Collusion – If firms collude instead of competing, it leads to reduced
innovation, excessive advertising costs, and lack of price transparency,
ultimately disadvantaging consumers.
•Price Wars Leading to Market Domination – While price wars can
temporarily benefit consumers, they can also drive weaker firms out of
business. This results in fewer firms and reduced competition in the long run.
•Reduced Competition Over Time – If some firms are eliminated due to price
wars, the remaining dominant firms will face even less competition, leading to
potential price increases and fewer consumer choices.
In the UAE, 87% of Dubai’s shopping malls are owned by just five firms. The retail sector is predicted to reach
$71bn in sales by 2021 and employ 25% of Dubai’s workforce. Each shopping mall offers something different to
customers, for example an indoor ski slope or an indoor aquarium. Dubai’s retailers benefit from its tourism
sector, as the city ranks as one of the busiest shopping destinations in the world. (Source adapted from:
https://wwd.com/business-news/technology/savant-data-systems dubai-retail-report-10956883/)
(i) With reference to the data above and your knowledge of economics, analyse why the shopping malls in Dubai
are considered to be an oligopoly.