Microeconomics for Business
Oligopolyis a market that is dominated by a small numbers of sellers who arereferred to as oligopolies. An oligopoly can be as a result ofcollusion between business organizations in the market to reducecompetition or the existence of barriers to the market. Due to therelatively small number of players in the market, the sellers areaware of the activities of other sellers. This means that a decisionby one seller can have an influence on other sellers in the market.On the other hand, major decision puts into consideration thedecision of other firms in the markets. In an oligopoly market, thelikely response of other players in the market is very critical.There are several characteristic of an oligopoly market.Additionally, in many oligopoly markets, the players are likely todevelop restrictive market strategies such as collusion and sharingof the market in an attempt to maximize profit by increasing pricesor restricting production. This way, the market acts relatively thesame as a monopoly market. A good example of a collusion leading acartel is evident in the international market when the sellerscolluded to establish Pa cartel know as OPEC which has a directcontrol over the oil market. Although these collusions are illegal insome countries, they can be used to stabilize a market, reduce risksin the market and promote development in the product. Moreover, someof these collusions occur without formal agreement and thereforethere is no evidence of their existence (Perloff, 2008).
Oligopoliesare characterized by maximum profits and abnormal profits in the longrun due to the ability of the sellers to set prices. This means thatthe seller is a price setter rather than a price taker common in amarket influence by demand and supply forces. It is alsocharacterized by huge barrier to new entrants mainly due to massiveinvestment requirement, patents, complex and inaccessibletechnologies, government regulations or strategic actions by theexisting firm to discourage new entrants. However, productdifferentiation in an oligopoly market can range from differentiatedproduct to homogenous products. The most distinctive characteristicof an oligopoly is the interdependence between the sellers in themarket. Basically, an oligopoly market is composed of large sellerswhich have an influence on the market dynamics. This means that thesuccess of one seller is dependent on the actions of the othersellers in the market (Perloff, 2008). For example, a seller in anoligopolistic market may consider lowering the price as a marketingstrategy, but should be worried about the response of the othersellers which could trigger a pricing war. This unique characteristicdifferentiates between an oligopoly from a perfectly competitive or amonopoly market. Due to the sensitivity of price wars in anoligopolistic market, they tend to compete in other aspects otherthan prices, for example, brand recognition, product differentiationand loyalty programs (Krugman, 2009). Examples of an oligopolisticmarket are the private health insurance or the aviation industry inthe United States.
Amonopolistic competition is a market that is not perfectlycompetitive due to many producers each having a monopoly of its owndifferentiated product. The market has many buyers and many sellers.However, each of the sellers has highly differentiated product inrelation to branding, quality, customer preference such that thereare no perfect substitutes. The seller is therefore concerned aboutthe price charged by the competitors and not the impact of theirprices on the market. Some of the basic characteristics of amonopolistic competition are the existence of large number ofproducers and consumers, who do not have individual influence on themarket. The consumer perception is that the prices for the competingproduct are the same but the producers have some control over prices.Since there are numerous buyers and sellers, there is no barrier fornew entrants (Perloff, 2008).
Althoughthere is a huge difference between a monopolistic competitive marketand perfectly competitive market, in the long run the two markets arethe same. In a perfectly competitive market, the products arehomogenous and thus perfect substitutes. On the other hand, theproducts are heterogeneous in a monopolistic competition (Krugman &Obstfeld, 2008). However, a monopolistic competition is considered tobe an inefficient market because the cost of price regulations in themarket are more compared to the benefits. Additionally, producers inthis market do not operate at the minimum cost. Additionally,monopolistic competition promotes advertisement and sale promotionstrategies that focus on building the brand name. This induces morespending on a particular product by the consumer based on the brandrather than rational factors. This is ineffective because of lack ofsustainability. Monopolistic competition markets are very common inthe modern business environment. They are common in industries wheredifferentiation of products is possible, such as customer services,retailing, restaurants or general consumer products (Krugman, 2009).For example, in the toothpaste market, manufactures can differentiatetheir product through different packaging, composition of the productor claim of superior quality.
Perloff,J. (2008). MicroeconomicsTheory & Applications with Calculus.Boston: Pearson.
Krugman,W. (2009). Microeconomics(2nd ed.). New York: Worth.
Krugman,P. & Obstfeld, M. (2008). InternationalEconomics: Theory and Policy.Addison-Wesley. ISBN 0-321-55398-5.