ECONOMIC ANALYSIS: The process of investigating economic phenomena in a systematic manner. In one sense, this is the heart and soul of the economic discipline. While economists spend ample time identifying economic concepts, the end result of this discovery process is usually aimed at combining these concepts in such a way as to evaluate or analyze alternative consequences.
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The three most important characteristics of oligopoly are: (1) an industry dominated by a small number of large firms, (2) firms sell either identical or differentiated products, and (3) the industry has significant barriers to entry. These three characteristics underlie common oligopolistic behavior, including interdependent actions and decision making, the inclination to keep prices rigid, the pursuit of nonprice competition rather than price competition, the tendency for firms to merge, and the incentive to form collusive arrangements.
Small Number of Large FirmsThe most important characteristic of oligopoly is an industry dominated by a small number of large firms, each of which is relatively large compared to the overall size of the market. This characteristics gives each of the relatively large firms substantial market control. While each firm does not have as much market control as monopoly, it definitely has more than a monopolistically competitive firm.
The total number of firms in an oligopolistic industry is not the key consideration. A oligopoly firm actually can have a large number of firms, approaching that of any monopolistically competitive industry. However, the distinguishing feature is that a few of the firms are relatively large compared to the overall market. A given industry with a thousand firms, for example, is considered oligopolistic if the top five firms produce half of the industry's total output.
The hypothetical Shady Valley soft drink market contains 20 firms, but it is oligopolistic because the four largest firms account for over 60 percent of total industry sales and the top eight firms account for almost 80 percent.
Identical or Differentiate ProductsSome oligopolistic industries produce identical products, like perfect competition in this regard, while others produce differentiated products, more like monopolistic competition. This characteristic might seem to be a bit wishy-washy, taking both sides of product differentiation issue. In actuality it points out that oligopolistic industries general come in two varieties.
- Identical Product Oligopoly: This type of oligopoly tends to process raw materials or produce intermediate goods that are used as inputs by other industries. Notable examples are petroleum, steel, and aluminum.
- Differentiate Product Oligopoly: This type of oligopoly tends to focus on goods sold for personal consumption. The key is that people have different wants and needs and thus enjoy variety. A few examples of differentiated oligopolistic industries include automobiles, household detergents, and computers.
Barriers to EntryFirms in an oligopolistic industry attain and retain market control through barriers to entry. The most noted entry barriers are: (1) exclusive resource ownership, (2) patents and copyrights, (3) other government restrictions, and (4) high start-up cost.
Barriers to entry are the key characteristic that separates oligopoly from monopolistic competition on the continuum of market structures. With few if any barriers to entry, firms can enter a monopolistically competitive industry when existing firms receive economic profit. This diminishes the market control of any given firm. However, with substantial entry barriers found in oligopoly, firms cannot enter the industry as easily and thus existing firms maintain greater market control.
Consider the hypothetical oligopolistic Shady Valley athletic shoe market dominated by OmniRun, Inc. and The Master Foot Company. Each of these firms has produced athletic shoes for several years. They have well-known brand names, state-of-the-art factories that provide economies of scale for large volumes of production, and a few patents on how their shoes are made.
Any firm seeking to enter this market is faced with significant barriers.
While a new firm could enter this oligopolistic market, such a task is significantly more difficult than entering an industry with fewer barriers.
- First, a new firm must compete with the established Fleet Foot and OmniFast brand names. At the very least, this requires a substantial amount of expensive upfront advertising and promotion.
- Second, a new entry has to construct a new factory. With limited initial sales, this new firm in the market will be unable to take full advantage of decreasing short-run average cost or long-run economies of scale.
- Third, any new firm has to devise its own production techniques to compete with the patented techniques used by OmniRun and Master Foot.
OLIGOPOLY, CHARACTERISTICS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: February 25, 2024].
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