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Oligopoly > Prerequisites of Oligopoly
Prerequisites of Oligopoly
• Few Sellers
• Product Differentiation
• Entry Barriers
• Price Leadership
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Oligopoly > Prerequisites of Oligopoly
Few Sellers
• The existence of oligopoly requires that a few firms are able to gain significant
market power, preventing other, smaller competitors from entering the market.
• Increasing returns to scale is a term that describes an industry in which the rate of
increase in output is higher than the rate of increase in inputs. In other words,
doubling the number of inputs will more than double the amount of output.
• Monopolies and oligopolies often form when an industry has increasing returns to
scale at relatively high output levels.
Cell Phone Tower
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Oligopoly > Prerequisites of Oligopoly
Product Differentiation
• Product differentiation is the process of distinguishing a product or service from
others, to make it more attractive to a particular target market.
• The objective of differentiation is to develop a position that potential customers
see as unique. This primarily affects performance through reducing competition.
• Many oligopolies make differentiated products: cigarettes, automobiles,
computers, ready-to-eat breakfast cereal, and soft drinks.
• Although product differentiation is not required for an oligopoly to form, if a firm
can successfully differentiate its products it will gain market power and resist
competition more easily.
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Oligopoly > Prerequisites of Oligopoly
Entry Barriers
• Because barriers to entry protect incumbent firms and restrict competition in a
market, they can contribute to distortionary prices.
• 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 new entrants.
• In industrialized economies, barriers to entry have resulted in oligopolies forming
in many sectors, with unprecedented levels of competition fueled by increasing
globalization.
Oligopoly in Aircraft Manufacturing
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Oligopoly > Prerequisites of Oligopoly
Price Leadership
• Oligopolies are defined by one firm's interdependence on other firms within the
industry. When one firm changes its price or level of output, other firms are
directly affected.
• When firms collude, they use restrictive trade practices to voluntarily lower output
and raise prices in much the same way as a monopoly, splitting the higher profits
that result.
• An alternative to overt collusion is tacit collusion, an unwritten, unspoken
understanding through which firms agree to limit their competition.
• One strategy is to follow the price leadership of a particular firm, raising or
lowering prices when the leader makes such a change. The price leader may be
Price Leadership and Gas Prices
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the largest firm in the industry, or it may be a firm that has been particularly good
at assessing changes in demand or cost.
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Appendix
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Oligopoly
Key terms
• Cartel A group of businesses or nations that collude explicitly to limit competition within an industry or market.
• collude To act in concert with; to conspire.
• incumbent A firm that is an established player in the market.
• oligopoly An economic condition in which a small number of sellers exert control over the market of a commodity.
• patent A declaration issued by a government agency declaring someone the inventor of a new invention and having the
privilege of stopping others from making, using, or selling the claimed invention.
• Price leadership The action taken by a leader in an oligopolistic industry to determine prices for the entire industry.
• product differentiation Perceived differences between the product of one firm and that of its rivals so that some customers value
it more.
• research and development The process of discovering and creating new knowledge about scientific and technological topics in
order to develop new products
• returns to scale A term referring to changes in output resulting from a proportional change in all inputs (where all inputs
increase by a constant factor).
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Oligopoly
Cell Phone Tower
Cell phone companies have increasing returns to scale, which leads to a market dominated by only a few firms.
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Oligopoly
Price Leadership and Gas Prices
Although companies cannot legally communicate to set prices, some accuse certain industries of using price leadership to accomplish the same goal.
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Oligopoly
Advertising for Product Differentiation
Some companies are able to use marketing to achieve product differentiation, encouraging the formation of oligopolies.
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Oligopoly
Oligopoly in Aircraft Manufacturing
Manufacturing commercial airplanes takes a very large initial investment in technology, equipment, and licensing. Consequently, the industry is
dominated by two firms.
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Oligopoly
Which of the following situations has increasing returns to scale?
A) A larger cell phone provider can serve more customers per cell tower
than a smaller provider
B) A factory produces a smaller increase in output for each added worker
due to overcrowding
C) A fast food company can serve an extra 10,000 customers with each
new restuarant it opens
D) A grocery store that is twice the size of its competitor serves twice the
number of customers
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Oligopoly
Which of the following situations has increasing returns to scale?
A) A larger cell phone provider can serve more customers per cell tower
than a smaller provider
B) A factory produces a smaller increase in output for each added worker
due to overcrowding
C) A fast food company can serve an extra 10,000 customers with each
new restuarant it opens
D) A grocery store that is twice the size of its competitor serves twice the
number of customers
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Oligopoly
Will an industry with increasing returns to scale be more or less
likely to be an oligopoly than an industry with decreasing returns
to scale?
A) More likely, because it is more difficult for small competitors to enter
the market
B) More likely, because increasing returns to scale make the industry
more profitable overall
C) Less likely, because it is more difficult for small competitors to enter
the market
D) Less likely, because decreasing returns to scale make the industry
more profitable overall
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Oligopoly
Will an industry with increasing returns to scale be more or less
likely to be an oligopoly than an industry with decreasing returns
to scale?
A) More likely, because it is more difficult for small competitors to enter
the market
B) More likely, because increasing returns to scale make the industry
more profitable overall
C) Less likely, because it is more difficult for small competitors to enter
the market
D) Less likely, because decreasing returns to scale make the industry
more profitable overall
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Oligopoly
Which of the following is an example of an oligopoly practicing
product differentiation?
A) A toy company begins manufacturing clothing in order to reach a
broader market
B) A car manufacturing company uses advertising to create an upscale
image for its product
C) A steel company uses a new refining technology with increasing
returns to scale
D) All of these answers
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Oligopoly
Which of the following is an example of an oligopoly practicing
product differentiation?
A) A toy company begins manufacturing clothing in order to reach a
broader market
B) A car manufacturing company uses advertising to create an upscale
image for its product
C) A steel company uses a new refining technology with increasing
returns to scale
D) All of these answers
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Oligopoly
Which of the following is an example of a barrier to entry?
A) Zoning restrictions
B) High research and development costs
C) All of these answers
D) Patents
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Oligopoly
Which of the following is an example of a barrier to entry?
A) Zoning restrictions
B) High research and development costs
C) All of these answers
D) Patents
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Oligopoly
Which of the following is a form of collusion among oligopolies?
A) Price leadership
B) Cartel formation
C) All of these answers
D) Price fixing
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Oligopoly
Which of the following is a form of collusion among oligopolies?
A) Price leadership
B) Cartel formation
C) All of these answers
D) Price fixing
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Oligopoly
Attribution
• Wikipedia. "Returns to scale." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Returns_to_scale
• Wikipedia. "Oligopoly." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Oligopoly
• Wiktionary. "oligopoly." CC BY-SA 3.0 http://en.wiktionary.org/wiki/oligopoly
• Wikipedia. "returns to scale." CC BY-SA 3.0 http://en.wikipedia.org/wiki/returns%20to%20scale
• Wikipedia. "Product differentiation." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Product_differentiation
• Wikipedia. "Oligopoly." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Oligopoly
• Wiktionary. "product differentiation." CC BY-SA 3.0 http://en.wiktionary.org/wiki/product+differentiation
• Wikipedia. "Barriers to entry." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Barriers_to_entry
• Wikipedia. "Oligopoly." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Oligopoly
• Wiktionary. "incumbent." CC BY-SA 3.0 http://en.wiktionary.org/wiki/incumbent
• Wiktionary. "patent." CC BY-SA 3.0 http://en.wiktionary.org/wiki/patent
• Wikipedia. "research and development." CC BY-SA 3.0 http://en.wikipedia.org/wiki/research%20and%20development
• Wikipedia. "Oligopoly." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Oligopoly
• Wikipedia. "Price leadership." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Price%20leadership
• Wiktionary. "Cartel." CC BY-SA 3.0 http://en.wiktionary.org/wiki/Cartel
• Wiktionary. "collude." CC BY-SA 3.0 http://en.wiktionary.org/wiki/collude
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