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OLIGOPOLY, BEHAVIOR:

Oligopolistic industries share several behavioral tendencies, including: (1) interdependence, (2) rigid prices, (3) nonprice competition, (4) mergers, and (5) collusion. In other words, each oligopolistic firm keeps a close eye on the decisions made by other firms in the industry (interdependence), are reluctant to change prices (rigid prices), but instead try to attract customers from the competition using incentives other than prices (nonprice competition), and when they get tired of competing with their competitors they are inclined to cooperate formally and legally (mergers) or informally and illegally (collusion).
Oligopolistic industries are nothing if not diverse. Some sell identical products, others differentiated products. Some have three or four firms of nearly equal size, others have one large dominate firm (a clear industry leader) and a handful of smaller firms (that follow the leader). Some sell intermediate goods to other producers others sell consumer goods directly to the public.

However, through this diversity, all oligopolistic industries engage in similar types of behavior. The most noted behavior tendencies are: (1) interdependent decision making, (2) relatively constant prices, (3) competition in ways that do not involve prices, (4) the legal merger of two or more firms, and (5) the illegal collusion among firms to control price and production.

Interdependence

Each firm in an oligopolistic industry keeps a close eye on the activities of other firms in the industry. Because oligopolistic firms engage in competition among the few, decisions made by one firm invariably affect others. Competition among interdependent oligopoly firms is comparable to a game or an athletic contest. One team's success depends not only on its own actions but the actions of its competitors. Chip Merthington might win a foot race not just because he runs really fast, but because his competition (Edgar Millbottom) runs really slow.

In a game of chess, Chip captures Edgar's knight with his rook. Edgar then counters by capturing Chip's rook with his queen. The key point is that Edgar would not have taken Chip's rook if Chip had not captured Edgar's knight. This is how oligopolies behave. An action by one firm motivates a counter action by another firm.

Consider, for example, the hypothetical oligopolistic athletic footwear industry, dominated by two companies OmniRun, Inc. and The Master Foot Company. If OmniRun introduces the OmniFast 9000, a new running shoe with ankle stabilizers and an extra thick cushioned insole, then The Master Foot Company needs to introduce a comparable shoe to keep pace with the competition because its existing model, the Fleet Foot 30, does not have ankle stabilizers nor an extra thick cushioned insole. If The Master Foot Company does not counter the action by OmniRun, then buyers will likely choose the new OmniFast 9000 over the older Fleet Foot 30.

As such, The Master Foot Company will probably introduce something like the Fleet Foot 40 with flexible ankle stabilizers, a double extra thick cushioned insole, and metallic heal reflectors. And when it does, it is also likely to launch a massive advertising campaign to promote the new shoe, using the well-known, and wildly popular baseball superstar, Harold "Hair Doo" Dueterman as a spokesperson. This is likely to prompt OmniRun, Inc. to launch its own advertising blitz for the OmniFast 9000 featuring motion picture box office mega-star, Brace Brickhead.

And on it goes... each firm taking action to counter that of the other firm, which then takes further action, which then prompts more action.

Rigid Prices

Oligopolistic industries tend to keep prices relatively constant, preferring to compete in ways that do not involve changing the price. The prime reason for rigid prices rests with the interdependence among oligopolistic firms.
  • Because competing firms ARE NOT likely to match the price increases of an oligopolistic firm, the firm is likely to loose customers and market share to the competition should it charge a higher price. As such, it has little motive to increase its price.

  • Because competing firms ARE likely to match the price decreases of an oligopolistic firm, the firm is unlikely to gain customers and market share from the competition should it charge a lower price. As such, it has little motive to decrease its price.

Consider, once again, the oligopolistic athlete shoe industry. OmniRun, Inc. sells its OmniFast 9000 shoe for $100. Likewise, The Master Foot Company sells its Fleet Foot 40 running shoe for $100.

OmniRun could reduce the price of its OmniFast 9000 to $95, thinking buyers will select it over the more expensive Fleet Foot 40. But Master Foot is not likely to sit idly by as OmniRun dominates the market by virtue of a lower price. Master Foot will reduce the price of the Fleet Foot 40 to $95 as well.

The net result of this joint price reduction is that each firm retains the same market share, but sells its shoe for $5 less. While the lower overall shoe price might increase the overall quantity demanded in the market (due to the law of demand), neither firm gains a competitive advantage over the other. Both maintain the same market share at the $95 price as they had with the $100 price.

To the extent that OmniRun realizes Master Foot will match any price reduction, it has little motivation to reduce prices.

Master Foot also has little motivation to pursue a price increase of its Fleet Foot 40 to $105. OmniRun is unlikely to match this higher price. If the higher Fleet Foot 40 price is $5 more, the OmniFast 9000 is $5 cheaper. Buyers will select the less expensive OmniFast 9000 over the now more expensive Fleet Foot 40. As such, The Master Foot Company has nothing to gain with a higher price, but it is likely to lose market share to OmniRun.

The net result is that neither firm can gain a competitive advantage by changing the price. As such, the seek to compete in ways that do not involve price changes.

However, this does not mean prices in oligopolistic industries NEVER change. Should industry-wide conditions change, such as higher input prices, regulatory changes, or technological advances, conditions that affect all firms, then all firms are likely respond in the same manner. They are likely to raise or lower prices together.

Should the Athletic Shoe Workers Union negotiate an across-the-board 10 percent wage increase, then OmniRun and Master Foot are both inclined to raise shoe prices to the same degree. Should Professor Magnaminious, the leading expert on athletic shoe fabrication, design a new athletic shoe assembly machine that is twice as productive as the old assembly method, then OmniRun and Master Foot are both inclined to reduce shoe prices to the same degree.

Nonprice Competition

Because oligopolistic firms realize that price competition is ineffective, they generally rely on nonprice methods of competition. Three of the more common methods of nonprice competition are: (1) advertising, (2) product differentiation, and (3) barriers to entry. The key for a firm is to attract buyers and increase market share, while holding the line on price.
  • Advertising: A large share of commercial advertising, especially at the national level, is designed as nonprice competition among oligopolistic firms. The Master Foot Company, as a hypothetical example, promotes its Fleet Foot 40 running shoe using the baseball superstar, Harold "Hair Doo" Dueterman, as a spokesperson. OmniRun, Inc. counters with advertising for the OmniFast 9000 featuring motion picture mega-star, Brace Brickhead. Each firm engages in advertising is an attempt either: (a) to attract customers from its competition or (b) to prevent the competition from attracting its customers.

  • Production Differentiation: Another common method of nonprice competition among oligopolistic firms is product differentiation. Such firms often compete by offering a bigger, better, faster, cleaner, and newer product--and especially one that is different from the competition. This is the reason why OmniRun might introduce its OmniFast 9000, with ankle stabilizers and an extra thick cushioned insole. This is also the reason why The Master Foot Company might introduce its Fleet Foot 40 with flexible ankle stabilizers, a double extra thick cushioned insole, and metallic heal reflectors. Each firm seeks to differentiate its product and to give customers a reason (other than price differences) to select its product over the competition.

  • Barriers to Entry: Oligopolistic firms also frequently "compete" by preventing the competition from entering the industry. Master Foot, for example, has a patent on the design of its innovative Fleet Foot 40 shoe which, for obvious reasons, it does not care to share with any potential competitors. Alternatively, OmniRun has acquired exclusive ownership of the world's supply of plaviminium (the material used to make the extra thick cushioned insole of the OmniFast 9000), which it is not inclined to sell to potential competitors. While assorted entry barriers exist, a popular form is government restrictions, especially if the competition happens to reside in another country.

Mergers

Interdependence means that oligopolistic firms perpetually balance the need for competition against the benefits of cooperation. OmniRun and Master Foot are competitors in the market for athletic shoes. The profitability of OmniRun depends on the actions of Master Foot and vice versa. Such competition is inherent in an industry with a small number of large firms.

However, oligopolistic firms also realize that cooperation is often more beneficial than competition. One common method of cooperation is through a merger, that is, the legally combination of two firms into a single firm. OmniRun, for example, can eliminate its number one competitor, Master Foot, by merging with it and forming a new, larger company (MasterRun or perhaps OmniFoot). With such a merger, OmniRun now has one less competitor to worry about. If Master Foot is OmniRun's only competitor, then this merger gives OmniRun a monopoly in the athletic shoe market. In general, as the number of competitors in an industry declines, then market control of the remaining firms is enhanced.

Because oligopoly has a small number of firms, the incentive to cooperate through mergers is quite high. The large number of firms in monopolistic competition, by contrast, provides very few merger benefits. The merger of two monopolistically competitive firms, each with one-thousandth of the overall market, does not enhanced market control much at all. However, the merger of two oligopolistic firms, each with one-third of the market, greatly enhances the market control of the new firm.

Collusion

The incentive among oligopolistic firms to cooperate also takes the form of collusion. With collusion, oligopolistic firms remain legally independent and autonomous, but they enjoy the benefits of cooperation. Collusion occurs when two or more firms secretly agree to control prices, production, or other aspects of the market. For example, OmniRun and Master Foot might secretly agree to raise their shoe prices to $150 a pair. If these are the only two firms in the market for athletic shoes, then buyers have no choice but to pay the $150 price. In effect, the two firms operate as if they were one firm, a monopoly.

By acting like a monopoly, the colluding firms can set a monopoly price, produce a monopoly quantity, generate monopoly profit; and allocate resources as inefficiently as a monopoly.

Collusion can take one of two forms. Explicit collusion results when two or more firms reach a formal agreement. Implicit collusion results when two or more firms informally control the market with necessarily reaching a formal agreement.

Given that collusion is usually illegal, especially within the United States, it is invariably kept secret. Some collusive agreements, however, are anything but secret. The most well-known example is the Organization of Petroleum Exporting Countries (OPEC). OPEC is an open, formal collusive agreement among petroleum producing countries to control prices and production.

<= OLIGOPOLY AND MONOPOLYOLIGOPOLY, CHARACTERISTICS =>


Recommended Citation:

OLIGOPOLY, BEHAVIOR, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: April 22, 2018].


Check Out These Related Terms...

     | oligopoly | oligopoly, characteristics | oligopoly, realism |


Or For A Little Background...

     | market structures | market control | firm | industry | competition among the few | short-run production analysis | production | elasticity alternatives | efficiency |


And For Further Study...

     | market share | concentration | kinked-demand curve | merger | horizontal merger | vertical merger | conglomerate merger | collusion | explicit collusion | implicit collusion | barriers to entry | product differentiation | game theory | perfect competition | monopoly | monopolistic competition |


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