User:TorinSchneid/Oligopoly

Types of oligopolies

The following characterisations of oligopolies broadly cover the many different types that have been considered in academic literature.

• Perfect and imperfect oligopolies

Perfect and imperfect oligopolies are often distinguished by the nature of the goods the firms in those markets produce or trade in.

A perfect (or sometimes called a 'pure') oligopoly is present where the commodities produced by the firms are homogenous (i.e., identical or materially the same in nature)^[1] and the elasticity of the substitution nears the infinite. Generally, where there are two homogenous products, a rational consumer's preference between the products will be indifferent (assuming the products share common prices), and similarly, sellers will be relatively indifferent between purchase commitments in relation to homogenous products.^[2] In the oligopolistic market of a primary industry, such as agriculture or mining, the commodities produced by such oligopolistic enterprises will have strong homogeneity, and as such are described as perfect oligopolies.

Imperfect (or 'differentiated') oligopolies, on the other hand, involve firms producing commodities which are heterogenous (i.e., diverse or different in content). The differentiation of goods in the manufacturing and service industries indicates that these firms are subject to an imperfect oligopoly. For example, different clothing companies may appeal to different demographics and thus need to produce a wide range of products, and different mobile phone brands have different functions and appearances, and as such offer a diverse range of products and services (the list goes on^[3]).

• Open and closed oligopolies

An open oligopoly market structure is considered to occur where the barriers to entry do not exist. Firms can freely enter the oligopolistic market. In contrast, a closed oligopoly is where there are prominent barriers to market entry in place which preclude other firms from entering the market so easily. Entry barriers include high investment requirements, strong consumer loyalty for existing brands, and economies of scale. These barriers allow existing firms in the oligopoly market to maintain a certain price on commodities and services which goes to the crux of their profit maximizing scheme.^[4]

• Collusive oligopoly

Collusion among firms in an oligopoly market structure occurs where there are express or tacit agreements (i.e.,

A firm which dominates an industry through saturation of the market (i.e., produces at a high percentage of total output) and has influence over market conditions, operates in such a way that it is able to price-make rather than price-take.[7] This sort of firm is a price leader in oligopoly theory, and in markets where there is a price leader who dominates the other firms (the 'followers') for market control, this is described as a partial oligopoly.

Ipso facto, a full oligopoly is one in which a price leader is not present in the market, and the firms enjoy relatively similar market control.

Characteristics of oligopolies

There are many characteristics of oligopolies. Some of these characteristics include:

• Profit maximization: an oligopoly will
  maximize
  its profits.
• Price setting: firms in an oligopoly market structure tend to be price setters rather than prices takers.
• High barriers to entry and exit: the most important barriers are government licenses, economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy nascent firms. Additional sources of barriers to entry often result from government regulation favoring existing firms making it difficult for new firms to enter the market.
• Few firms in the market (but more than one): there are so few firms that the actions of one firm can influence the actions of the other firms.
• Abnormal long run profits: Oligopolies retain abnormal long run profits. High barriers of entry prevent sideline firms from entering the market to capture excess profits. If the firms are colluding in the oligopoly, the firms can set the price at a high profit maximising level.
• Nature of the products: it can be homogeneous (for example steel) or heterogenous (for example automobiles).
• Perfect and imperfect knowledge: Assumptions about
  perfect knowledge
  vary, but the knowledge of various economic factors can be generally described as selective. Oligopolies have perfect knowledge of their own cost and demand functions, but their inter-firm information may be incomplete. If the firms in the oligopolies are colluding, information between the firms then may become perfect. Buyers, however, only have imperfect knowledge as to price, cost, and product quality.
• Interdependence: the distinctive feature of an oligopoly is
  perfectly competitive (PC) market there is zero interdependence because no firm is large enough to affect market price. All firms in a PC market are price takers, as the current market selling price can be followed predictably to maximize short-term profits. In a monopoly, there are no competitors to be concerned about. In a monopolistically-competitive
  market, each firm's effects on market conditions are so negligible as to be safely ignored by competitors.

Economies of scale occurs where a firm's average costs per unit of output decreases but the scale of the firm or output being produced by the firm increases.[8] This inverse relationship between the costs and the scale of the firm leads to the firm being more productive and economically efficient. Firms in an oligopoly who benefit from economies of scale have a distinct advantage over firms who do not. Their marginal costs are lower and the firm's equilibrium at ${\displaystyle MR=MC}$ would be higher.^[9] Economies of scale is seen prevalently when two firms in oligopolistic market agree to a merger, as it not only allows the firm to diversify their market, but also allows the firm to increase in size and output production with negligible relative increases in output costs.^[10]

• Collusion and price cutting [remember to add in all the sources]

In a market with low entry barriers, price collusion between established sellers makes new sellers vulnerable to undercutting. Recognizing this vulnerability, the established sellers will reach a tacit understanding to raise entry barriers to prevent new companies from entering the market. Even if this requires cutting prices, all companies benefit because they reduce the risk of loss created by new competition. In other words, firms will lose less for deviation and thus have more incentive to undercut collusion prices (obtain short-term deviated profit) when more join the market. The rate at which firms interact with one another is also expected to affect the incentives for undercutting other firms as the short-term rewards for undercutting competitors will be short lived where interaction is frequent and a degree of 'punishment' can expected swifty by other firms, but longer-lived where interaction is infrequent. Resultingly greater market transparency, in this case pertaining to the knowledge other firms have of prices and quantities of sales in rival firms, would decrease collusion. As oligopolistic companies would expect retaliation sooner where changes in their prices and quantity of sales are clear to their rivals.

• Barriers to enter the market

The barriers to enter into an oligopoly market have been discussed previously, but it is also a fundamental source of an oligopoly's power. The large capital investments required for entry, the intellectual property laws, certain network effects,^[11] absolute cost advantages,^[12] reputation, advertisement dominance,^[13] product differentiation,^[14] brand reliance, and others, all contribute to keeping existing firms in the market and precluding new firms from entering.

Modeling oligopolies

Game theory models

With few sellers, each oligopolist is likely to be aware of the actions of their competition. According to game theory, the decisions of one firm influence and are influenced by the decisions of other firms. Strategic planning by oligopolists needs to take into account the likely responses of the other market participants. Oligopoly theory makes heavy use of game theory to model the behavior of oligopolies:

• Stackelberg's duopoly. In this model, the firms move sequentially (see Stackelberg competition).
• Cournot's duopoly. In this model, the firms simultaneously choose quantities (see Cournot competition).
• Bertrand's oligopoly. In this model, the firms simultaneously choose prices (see Bertrand competition
  ).

As a quantitative description of oligopoly, the four-firm concentration ratio is often utilized and is the most preferable ratio for analyzing market concentration. This measure expresses, as a percentage, the market share of the four largest firms in any particular industry. For example, as of fourth quarter 2008, if we combine the total market share of Verizon Wireless, AT&T, Sprint, and T-Mobile, we see that these firms, together, control 97% of the U.S. cellular telephone market. These four cellular telephone firms have become the top-tier in US carriers and were protected by the US government that acted as an intervention for other firms entering the market.

Oligopolies in countries with competition laws

In developed economies, oligopolies dominate, as the perfectly competitive model is of negligible importance for consumers.^{[citation needed]} Specifically, oligopolists will price fix, a practice that lessens buyer choice and raises prices, to dominate these markets. Most new prosecuted oligopoly cases in the US in 2013 were based on price-fixing.

Countries' attempt to police anticompetitive behaviour

For fighting collusion and cartels in an oligopoly market, competition authorities have taken measures or practices to effectively discover, prosecute and penalize them. Leniency program and economic analysis (screening) are currently two popular mechanisms.

Leniency program

Competition authorities prominently have roles and responsibilities on prosecuting and penalizing existing cartels and desisting new ones. Thus, authorities have created an effective tool called the leniency program, which makes antitrust firms to be more proactive participants in confessing their collusion behaviors in that they will be granted immunity from fines and still have a right to plea bargaining if not receive a full reduction. Nowadays, leniency program has been implemented by several countries like US, Japan and Canada. However, it causes negative impacts to competition authorities themselves in the wake of abusing of leniency program that there are still many cartels in society and the expected sanctions for colluded firms will experience a sharp drop. As a result, the total effect of the leniency program is ambiguous and an optimal leniency program is required.

Economic analysis (screening)

There are two screening methods that are currently available for competition authorities: structural and behavioral. In terms of structural screening, it refers to identify industry traits or characteristics, such as homogeneous goods, stable demand, less existing participants, which are prone to cartel formation. While regarding behavioral one, is mainly implemented when a cartel formation or agreement has reached and subsequently authorities start to look into firms' data and figure out whether their price variance is low or has a significant price increase or decrease.

Oligopolies in international trade

International trade has increased from $5 trillion USD in 1994 to $24 trillion USD in 2014. Following current trends, this number will only increase in the future as an increasing of firms are now competing internationally. Different from domestic oligopolies, international oligopolies have to consider importing and exporting tariffs as countries have different international policies. This is described as “strategic trade policy” and uses both the Bertrand and Cournot models as examples of interdependence.

Game theory is used when theorizing international trade theory. The added features are “That oligopolistic firms would treat markets in each country as segmented rather than integrated and the second, that countries had a motive to raise domestic welfare by shifting rents from foreign firms to the domestic economy in the form of higher domestic profits, increased government revenue or above-normal wages.” (Head & Spencer, 2017).

Possible outcomes of oligopoly market structures

Formation of cartels

Oligopolistic competition can give rise to a wide range of outcomes. In some situations, particular companies may employ restrictive trade practices (collusion, market sharing etc.) in order to inflate prices and restrict production in much the same way that a monopoly does. Whenever there is a formal agreement for such collusion between companies that usually compete with one another, this practice is known as a cartel. A prime example of such a cartel is OPEC, where oligopolistic countries manipulate the worldwide oil supply and ultimately leaves a profound influence on the international price of oil.

There are legal restrictions on such collusion in most countries and relevant regulations or enforcements against cartels (anti-competitive behaviours) enacted since the late of 1990s. For example,

In other situations, competition between sellers in an oligopoly can be fierce, with relatively low prices and high production. Hypothetically, this could lead to an efficient outcome approaching perfect competition. The competition in an oligopoly can be greater when there are more competitors in an industry. Theoretically, it is harder to sustain cartels (anti-competitive behaviors) in an industry with a larger number of firms in that it will yield less collusive profit for each firm. Consequently, existing firms may have more incentive to deviate. However, this conclusion is a bit more intuitive and empirical evidence has shown this conclusion or relationship is a bit more ambiguous and mixed.

Thus the