Oligopoly

What is oligopoly?

Another market type that stands between perfect competition and monopoly.

Oligopoly is a market type in which:

• A small number of firms compete to supply the market for goods or services. I.e. petrol (or gas for the Americans reading)- its the same product but its oligopolistic because each petrol company differentiates their petrol through advertisement- ie one petrol station might advertise their petrol says its the cheapest around while the other petrol station claims to have the highest quality petrol around.

Natural (i.e. monopolisation and high startup costs to start a business); or legal barriers prevent the entry of new firms into the market (i.e. contracts, patents, and licenses).

• Small Number of Firms

In contrast to monopolistic competition and perfect competition, an oligopoly consists of a small number of firms.

• Each firm has a large market share (market share is the portion of a market controlled by a particular company or product).

• The firms are interdependent (can't act independently of each other).

• The firms have an incentive to collude (they want to work together to get the most profit but cannot- I would suggest watching a video on this as the topic of cartels is quite interesting but can be confusing when the prisoners dilemma is introduced).

• Key is are the markets workably competitive
• In addition to studying the factors affecting competition, we will also consider competitive outcomes in the grocery sector.

This will likely focus on:

• prices, choice, quality and innovation in the sector;
• the margins and profitability of grocery retailers; and
• whether there are other outcomes that are not consistent with those expected in a workably competitive market.

• Definition of workability
• The High Court has noted the following points regarding workable competition: “A workably competitive market is one that provides outcomes that are reasonably close to those found in strongly competitive markets… The degree of rivalry is critical. In a workably competitive market no firm has significant market power and consequently prices are not too much or for too long significantly above costs… In our view, what matters is that workably competitive markets have a tendency towards generating certain outcomes”

How might they work together accommodating behaviour

• Coordinated behaviour involves firms recognising that they can reach a more profitable outcome if they act to limit their rivalry when taking each other’s actions into account (such as by following a rival’s price increases). Collusion (coordinated behaviour) could lead to worse outcomes for consumers such as higher prices, or reduced choice or quality and therefore it is illegal in most countries.

• Such conduct does not necessarily require an explicit agreement or express coordinated behaviour between competing firms, which may breach cartel laws.

• It can develop instead by firms repeatedly observing each other’s actions and reactions so that they reach an implicit understanding to accommodate each other’s actions.

Accommodating behaviour is a potential outcome in concentrated oligopoly markets.

However, this is not inevitable – several conditions must hold for it to occur, including:

firms must be able to reach similar views on how they can increase industry profits;

firms must be able to detect and punish cheating, so that the individual profit gains from a firm’s cheating are outweighed by the costs of punishment; and the coordinated behaviour must not be undermined by threat of entry or expansion by other firms, or the ability of consumers to disrupt coordination.

• Grocery retailers could potentially accommodate each other’s behaviour in several ways, including through:

location of store openings;

offerings at their respective stores (for example, opening hours and store quality); and prices and promotional schedules.

• For example, a particular retailer might take the role of price leader, with other retailers following the leader’s price movements. Regarding promotional schedules, retailers could potentially work with suppliers to ensure that they do not clash.

Buyer power

• Supermarkets are often recognised as having significant buyer power, because suppliers can be dependent on them as a main route to sell their products to consumers. This is true as well- suppliers (i.e. farmers) do not have any buyer power or control of supermarket prices in NZ at least. Supermarkets can also be considered to have great buyer and supplier power because they can choose not to stock goods in order to create higher demand from consumers- then they can all of a sudden supply the good in shortage and increase price as consumers will be more willing to pay higher prices for the good and they will bid up the price for that good.

New Zealand’s major grocery retailers source products from many suppliers. Many of these suppliers are small relative to the retailer they supply, and dependent on those retailers in order to sell their products to consumers.

Retailers, on the other hand, are often likely to be able to obtain similar products by alternative means and are therefore less likely to be dependent on any particular supplier for sales. This may tip the balance of bargaining power in favour of the major grocery retailers in some cases.

• However, if used in certain ways, it is possible that too much buyer power in the hands of retailers could lead to worse outcomes for consumers. For example, this could be the case if retailers use their buying power to:

place excessive risks on suppliers, reducing their ability and incentive to invest and compete; or enter into restrictive supply arrangements which limit a supplier’s ability to sell its products via other retailers.

Abuse of market power

• Examples of “behaviours caused by a lack of competitive pressure on ‘powerful purchasers’”, including retailers:

requesting retrospective cash payments compensation (adding to an employee's pay check to make up for a compensation shortfall in a previous pay period);

refusing to accept price increases despite rising supplier costs;

unilaterally imposing additional costs or discounting items without prior agreement;

refusing to pay agreed costs to suppliers; and threatening or exacting retribution as a negotiating tactic.

Interdependence

When a small number of firms compete in a market, they are interdependent in the sense that the profit earned by each firm depends on the firm’s own actions and on the actions of the other firms.

Before making a decision, each firm must consider how the other firms will react to its decision and influence its profit.

Temptation to Collude

When a small number of firms share a market, they can increase their profit by forming a cartel and acting like a monopoly.

A cartel is a group of firms acting together to limit output, raise price, and increase economic profit.

Cartels are illegal but they do operate in some markets.

Despite the temptation to collude, cartels tend to collapse.

• Barriers to Entry

Either natural or legal barriers to entry can create an oligopoly.

Natural barriers arise from the combination of the demand for a product and economies of scale in producing it.

If the demand for a product limits to a small number the firms that can earn an economic profit, there is a natural oligopoly.

The oligopolist's dilemma

Oligopoly might operate like monopoly, like perfect competition, or somewhere between these two extremes.

• Monopoly Outcome

The firm would operate as a single-price monopoly.

• Is Oligopoly Efficient?

In oligopoly, price usually exceeds marginal cost (the price of suppling one more unit of product).

So the quantity produced is less than the efficient quantity.

Oligopoly suffers from the same source and type of inefficiency as monopoly.

Because oligopoly is inefficient, antitrust laws and regulations are used to try to reduce market power and move the outcome closer to that of competition and efficiency.