An oligopoly market

An oligopoly market is one in which there are few sellers and an infinite number of buyers. These sellers may be marketing comparable or distinct goods. This few sellers control the market and, as a result, set commodity prices. A perfect oligopoly exists as two or more companies trade in complementary goods. Firms offering distinct goods are the hallmarks of an incomplete oligopoly. The purpose of this paper is to debate the argument that collusion is an unavoidable result of oligopoly.

Oligopolistic markets have distinct traits, such as a scarcity of vendors. In this market there are few firms supplying the good or service. On the other hand, there is a great number of buyers. This imbalance between the suppliers and the clients give the few firms total control over the prices. Secondly, the firms are interdependent of one another. In this market there are few suppliers. Therefore, each firm must carefully evaluate the actions of the other. In order to maintain a market, share a firm must comply swiftly to any change that the rival firm makes. If one firm lowers the prices, then the other firms must develop a countermeasure tactic to maintain their market share. Notwithstanding, this market is characterized by heavy advertising. The firms involved in this market are always trying to reach out to new customers. A firm that invests heavily in its brand promotion stands to benefit more from increased sales. As a result, the firms must invest heavily in their advertising strategies before they lose their market share. Additionally, this market has some entry barriers. Due to the large sizes of the firms that are involved, new entrants often find it difficult to enter the market. This is because the firms already operating in these markets have an edge over new entrants. They are already enjoying the economies of scale. Also, acquisition of government license to enter such a market might be difficult (Tishler, A. and Milstein, I., 2009). Technology used to set up firms to such kind of markets is quite complex. Complex technology calls for massive initial capital investment. Therefore, these factors combined make it quite difficult for a new entrant to enter this market. Lastly this market suffers from a lack of uniformity. The firms that are involved in this market differ considerably in terms of their sizes. Some are small compared to others. This differences in size play a huge factor in determining which firm gets what share of the market.

As a result of the stiff competition of the market oligopolies may provide the following advantages;

Enhances price stability. Stable prices of commodities help the consumer plan ahead. This has the net effect of stabilizing the consumer’s expenditure. A stable price is also essential in stabilizing the market trading cycle. Secondly, oligopolistic markets promote innovation and production of new and better products in the market. To increase the market, share firms constantly come up with innovative ideas. The ideas are meant to increase their customer bases, but in the long run, the customers are treated to a better product. Lastly, the consumers in a homogeneous oligopoly might enjoy relatively lower prices. Low prices attract more clients as such each, and every firm is cautious not to lose its market share by hiking its prices.

Disadvantages of oligopoly markets

These markets suffer from cartel-like behaviors. The few firms operating in this market can collude to keep prices high while at the same time offering low-quality products. Secondly, due to lack of free entry into these markets. These market customer choices are limited to the few items that are being provided. The choice is between which firm to get the goods from and not a variety of the goods. Moreover, the market lacks proper competition as such the oligopolists can engage in unethical manipulation of prices. The prices of the consumer goods are set at the mercies of the oligopolists.

Conjectural variations.

In the earliest oligopoly models, oligopolistic behavior assumes that firms formed expectations about the reactions of other firms. This interdependence is referred to as conjectural variations. The first conjectural model was developed by Cournot. In his model he illustrated that a firm would make one of the simplest possible assumptions about the other firms’ behavior that they will continue to produce the same level of output regardless of how the market behaves. This, therefore, implies that each firms conjecture is that the rival firm will go on selling their current production quantity. This kind of assumptions leads to a clear behavioral implication. However, this behavior is arbitrary and may not be the correct position of the competing firms.

However, this variations nature has their shortcomings which include; first the conjectures that firms hold are based on assumptions. These arbitrary assumptions are quite difficult to uphold in the real market world. Each firm is intent on getting a bigger market share. Therefore, the firms might be compelled to use extra mechanisms and techniques to remain in a profitable business. Secondly, these conjectural variations models have different multi-period interpretations. The models are not based on credible strategies which do not contradict firm’s positions and beliefs. The dynamic conjectural variations are based on inconsistent actions and beliefs of trading.

For instance, using Cornets model, we can evaluate a pineapples supply by two firms in the same market. Let’s say that firm (A) produces 300 pineapples in the first period, and firm (B) produces 200 pineapples in the same period. Subsequent production of each firm will be based on the competitor’s previous production. Therefore, in the second period company A will use its best-response function and produce R1 (200) =360-Q2/2=260 pineapples. Firm (B) will also use its best response function and produce R2 (300) =360-Q2/2=210 pineapples. This practice continues into the subsequent production periods. Eventually, the production of each firm will converge to the Cournot’s equilibrium of 240 pineapples.

This multi-period interpretation of a Cournot model over time is unreasonable. Firms each firm can change its output production by considering what its rival firms are doing. Indeed, this will affect the volumes of rival firm’s production. This implies that although a firm may see that its rival firm’s dependence on Cournot conjecture is wrong, it continues to rely on the same wrong model to determine its production unit’s too. It continues to use its one period best response function in its unit’s production. The Cournot equilibrium is not active and does not give room for experimentation. For instance, Cournot’s conjecture model dictates that there will be no market reaction at equilibrium if a firm changes its production units. In the actual sense, a change in the units of production by a single firm will hurt the entire market operations.

For example, if the firm (B) increases its production suddenly, chances are that there will be a reduction in the market prices. This is because Firm (B) will be forced to sell its merchandise at a relatively lower price to facilitate more sales. Subsequently, the other firms will be forced to lower their prices to compete fairly with a company (B). If the other firms fail to do so, they risk losing their customer base to their rival. Alternatively, firm (B) may choose to lower its production units at Cournot equilibrium. As a result of its reduced market share, rival firms might choose to increase their production units to meet the market demands (Dixit, A., 2012). If there is no increase in the volumes of production by the other companies, the market prices will be forced to go up (Naik, P.A., Prasad, A. and Sethi, S.P., 2008). This is because there will be a deficit of supply and to bring the market to balance it will be essential for the remaining firms to sell their merchandise at a relatively higher price. A change in the number of units produced. This kind of market reaction leads to the conclusion that these models do not hold in the real market world.

Cournot model of duopoly

This model is also known as Cournot competition. It is a model of imperfect competition where two firms with identical cost functions compete with homogeneous products in a static setting. This kind of set up can be referred to as an imperfect competition market. An imperfect competition is a business competition in which the rules of perfect competition are not followed. In this market, the price of commodities is not determined by the forces of demand and supply. The equilibrium prices are reached by other influences. In this set up the prices of commodities can soar up above their marginal costs. This will lead to a low purchasing power on the consumer’s side this might lead to the industry having some inefficient levels of production.

In his duopoly model research Cournot considered two markets operating in a limited market. The total production of this two markets is guided by the equation p (Q) = a-QB where Q is the total units produced by each firm. Q=q1+q2. The two companies are bound to receive profits derived from a decision made by the two on how much to produce (Huck, S., Normann, H.T. and Oechssler, J., 2010). The cost will also play a factor in determining how much profit each firm receive. The cost function is guided by the equation TCi=C-qi

Cournot’s approach equilibrium.

First, this model puts into consideration two firms that are trading in a similar product. These two firms are operating in the same market. In this model, it is assumed that the owners produce their products without incurring any cost of production. This model thus analyses only the demand. It is also assumed that the firms have a clear-cut knowledge of the market and that the demand for the product is linear (Duval, Y. and Hamilton, S.F., 2012). Lastly, the model assumes that a firm is fully aware that regardless of their changes in the prices of the commodity their competitors will keep on producing the same quantity of products as they are producing at the moment.

For maximum results the first order condition becomes;

And in scenarios where qi=qj

In the above graph the reaction function is represented by the blue lines. Quantity is the key variable that is set by the other firm. The quantity variable function will take the following form.

This model tries to explain how the two firms react to the market. In essence, the two companies are vying to reap maximum profits from the market. As such, each firm must ensure that it gets a better share of the market. To make maximum returns the firms must each make larger volumes of sale and have the prices kept relatively. The problem of selling the firms products at a higher price poses a great threat to the firm in that they will lose their market share. While they retail their products at a higher price, their competitors might be selling at lower prices (Al-Nowaihi, A. and Levine, P.L., 2015). Consumers are always looking for the best deals that ensure they purchase items at lower prices as such the firm with the lower price gets the lion’s share of the market. Such a scenario would lead to a Nash equilibrium. In Cournot’s model, the market shares and profitability of each firm is maximized. This is achieved by defining the optimum prices. The prices for the two companies are set at par.

Conclusion

In an oligopolistic market the firms may decide to engage in a passive competition or engage in an aggressive competition. When aggressively competing for the firms may decide to use their advantages over the other to up their market share. For instance, a firm enjoying large economies of scale may decide to lower its prices below profitability with the aim of capturing the market (Schneider, V.E., 1962). As a result, the other firms may be compelled to lower their prices. Low prices will translate to low profits. In most cases, this has not been the case.

On the other hand, there are cases of passive competition. This is the most prevalent form of oligopoly markets. In a passive competition, firms set a given output that is to be supplied by each. In so doing the firms in collusion set high prices of the commodities. This practice results in relatively high profits. In most parts of the world, this has been the case (Mansur, E.T., 2004). Most managers have consistently met to deliberate on the number of units to be supplied by each firm and to set the market prices. This practice ensures that the firms reap maximum profits. They operate within regulated units being produced, with predetermined profits. Most governments have set up regulatory authorities to curb this vice, but in the long run, it has not been effective.

Firms have continuously colluded with the aim of making profits. This has been made possible by the limited number of new entrants into oligopolistic markets. Therefore, the few market players can collude and set up market prices in boardroom affairs. A free and fair market should be free from any collusion or human regulation (Friedman, J., 1982). The price of commodities should be set by the market forces of demand and supply. This because a free market which is both competitive and fair should offer all players a good platform to deliberate on their practices without being compelled into any pre-market negotiations. Therefore, it is inevitably clear that in an oligopolistic market collusion is inevitable. This is because the few market participants are hell bend at achieving maximum profits regardless of the prices. Therefore, the firms will collude to ensure that the prices remain high and the production remains relatively low to ensure maximum returns.

Reference List

Al-Nowaihi, A. and Levine, P.L., 2015. The stability of the Cournot oligopoly model: a reassessment. Journal of Economic Theory, 35(2), pp.307-321.

Dixit, A., 2012 A model of duopoly suggesting a theory of entry barriers. J. Reprints Antitrust L. & Econ., 10, p.499.

Duval, Y. and Hamilton, S.F., 2012. Strategic environmental policy and international trade in asymmetric oligopoly markets. International Tax and Public Finance, 9(3), pp.259-471.

Friedman, J., 1982. Oligopoly theory. Handbook of mathematical economics, 2, pp.291-634.

Huck, S., Normann, H.T. and Oechssler, J., 2010. Does information about competitors’ actions increase or decrease competition in experimental oligopoly markets? International Journal of Industrial Organization, 18(1), pp.29-87.

Mansur, E.T., 2004. Environmental regulation in oligopoly markets: A study of electricity restructuring.

Naik, P.A., Prasad, A. and Sethi, S.P., 2008. Building brand awareness in dynamic oligopoly markets. Management Science, 54(1), pp.29-138.

Schneider, V.E., 1962. Factors to consider in determining pricing policies of cooperative bargaining associations (Doctoral dissertation).

Tishler, A. and Milstein, I., 2009. R&D wars and the effects of innovation on the success and survivability of firms in oligopoly markets. International Journal of Industrial Organization, 27(4), pp.119-531.