Oligopoly and Firm

architecture
Instructor: Maharouf Oyolola
 Oligopoly : Meaning and Sources
• Oligopoly is a form of market organization
in which there are few sellers of
homogeneous or differentiated product.
• If there are only two sellers, we have a
duopoly.
• If the product sold is homogenous, we
have a pure oligopoly.
• If the product is differentiated, we have a
differentiated oligopoly.
• Some oligopolistic industries in the United
States are automobiles, Steel, electrical
equipment, cigarettes, soaps and
detergents.
• Some of the products (such as steel and
aluminum) are homogenous, while others
(automobiles, cigarettes, soaps and
detergents) are differentiated.
• Since there are only a few firms selling a
homogenous or differentiated product in
oligopolistic markets, the action of each
firm affects the other firms in the industry
and vice versa.
 Example
• When General Motors introduced price
rebates in the sales of its automobiles,
Ford immediately followed with price
rebates of its own.
• Since price competition can lead to
ruinous price wars, oligopolists prefer to
compete on the basis of product
differentiation, advertising, and service.
 Concentration ratios
• Concentration ratios: measures the degree by
which an industry is dominated by a few firms.
• These give the percentage of total industry sales
of the 4,8, or 12 largest firms in the industry (see
page 367 in the textbook)
• An industry in which the four-firm concentration
ratio is close to 100 is clearly oligopolistic, and
industries in which the ratio is higher than 50 or
60 percent are likely to be oligopolistic
 The Herfindahl Index (H)
• It is also another method of estimating the
degree of concentration in an industry.
• This is given by the sum of the squared
values of the market shares of all the firms
in the industry.
• The higher the Herfindahl Index, the
greater is the degree of concentration in
the industry.
 Example
• If there is only one firm in the industry
(monopoly), so that its market share is 100
percent, H=1002=10,000
• If there are 2 firms with market shares of 90
percent and 10 percent H=902+102=8200
• If each firm has a market share of 50 percent
H=5000
• With 100 equal-sized firms in the (perfectly
competitive) industry, H=100
 The Herfindahl Index (H)
• The Hefindahl index has become of great
practical importance since 1982, when the
Justice Department announced new
guidelines for evaluating proposed
mergers based on this index.
 Oligopoly models
• We will present
- The Cournot Model
• -The Cartel arrangements
• - The price Leadership model
 The Cournot Model
• The French economist Augustin Cournot
introduced the first formal oligopoly model
more than 160 years ago.
• This model is useful in highlighting the
interdependence that exists among
oligopolistic firms.
 Cartel Arrangements
• There are two types of cartel: The Centralized
cartel and the market-sharing cartel.
• The market-sharing cartel gives each member
the exclusive right to operate in a particular
geographical area.
• The centralized cartel, which is the most well-
known, is a formal agreement among the
oligopolistic producers of a product to set the
monopoly price, allocate output among its
members, and determined how profits are to be
shared. For instance, OPEC
 Example
• It is often asserted that OPEC was able to
sharply increase petroleum prices and profits for
its members by restricting supply and behaving
as a cartel.
• Current members of OPEC: Algeria, Nigeria,
Indonesia, Iran, Iraq, Saudi-Arabia, Venezuela,
Qatar, Kuwait, Libya and the United Arab
Emirates ( OPEC used to have 13 but Ecuador
and Gabon left) (see page 375)
 Price Leadership
• With price leadership, the firm that is
recognized as the price leader initiates a
price change and then other firms in the
industry quickly follow.
• The price leader is usually the largest or
dominant firm in the industry.
• The followers behave as perfect
competitors or price-takers.