Oligopolistic market
Economics – Entry barriers to Oligopolistic Markets
Introduction
An oligopolistic market is a market that is dominated by very few sellers (oligopolists).
Oligopolists are the results of several forms of collusion which discourage competition and
which ultimately lead to higher costs for the eventual consumers. Oligopolists are always likely
to be aware of the activities of the others. The business decision of one firm ultimately affects
and influences the decisions of the other firms. Oligopolistic competition results in different
outcomes. Some companies may practice restrictive business and trade practices in an effort to
increase the prices of its products by reducing and limiting production just as much as it’s
practiced in monopoly markets. (Colander, 2008) Many firms collude and come together in an
effort to moderate the market and stabilize the unstable prices and production in the market so as
to reduce the risks expected in such markets for overall investment and inherent product
development. In some countries it’s illegal to collude and increase prices arbitrarily. (Wiens,
1978) Price leadership is however rampant where a renowned market leader in production of
certain products usually sets the prices of goods and other industry players respond in the same
way. Oligopolistic market can be very fierce with very low prices and relatively high production
leading to an efficient outcome that is almost like perfect competition. (Hirschey, 2000) In
product differentiation sturdy it’s noted that oligopolies can lead to creation of excessive product
Economics – Entry barriers to Oligopolistic Markets 2
differentiation to stifle and reduce competition. The theory of Oligopoly applies and makes a lot
of use of the game theory to model its behaviors i.e. Stackelberg duopoly to model and move
sequentially in Stackelberg competition model, Cournot’s duopoly or Bertrand’s oligopoly
competition models. (Kreps, 1990)
The essential characteristics of Oligopoly markets are that they maximize their profits where
their production marginal costs are equivalent to the revenue expected. Oligopolies are certainly
the price setters in their respective markets rather than price takers.
Demand curve in Oligopolistic market
Demand is elastic above the Kink because all the prices remain the same for the other companies
but it’s inelastic below the kink because of introduction of price reduction to remain competitive
which leads to a price war. For oligopolistic markets, point E is the best production point which
is the kink point and the equilibrium point.
Economics – Entry barriers to Oligopolistic Markets 3
The entry to oligopolistic markets are generally restricted and barriers of economies to scale,
patent rights, expensive and very complex technology and the strategic locations and actions of
the incumbent firms are literally designed to discourage, prevent or even destroy other potential
firms willing to join such markets. The numbers of firms operating in these markets are so few
that the action of a single firm generally affects and influences the other firms. Oligopolies retain
abnormal profits for longer periods as the entry barriers to their markets prevent other firms from
entering into the market to participate and also capture the excessive profits. These products are
normally differentiated or homogeneous in nature. Oligopolies have perfect and complete
knowledge of their own costs and other demand functions but the information about the other
close firms may not be complete i.e. the inter-firm information is lacking. Buyers have
inadequate and imperfect knowledge concerning the price, cost and the quality of the product.
(Mundell, 1968) The firms in such markets are mostly dependent on each other for survival.
Like a game of chess, the other players in the market anticipate and act accordingly in response
to the actions of other players in the same market. They also tend to compete on their terms of
business or trade rather than the prices of their products i.e. their firms are mostly based on non
price competition. (Negbennebor, 2001)
The following are the barriers to oligopolistic markets;
Capital costs. The firms operating in oligopolistic markets have accumulated and invested huge
resources and complex technology to literally prevent or discourage other firms from entering
the market. The huge capital outlay and the fierce competition involved keeps a lot of potential
investors away as the chance of recovering the capital invested are uncertain or it will take many
years to give a meaningful figure on the returns of capital invested. The unrecoverable costs
Economics – Entry barriers to Oligopolistic Markets 4
known as sunk costs if they are presumably high will definitely discourage investment. (Hicks,
1939)
Limit pricing. The large firms in the market may practice predatory pricing technique or policy.
It’s a technique designed to kill competition by the reduction of prices to costs that are slightly
below the production costs for some time to make the firms entering the market to have
unsustainable profits or make it impossible for the firms to sell their products. Limit pricing and
Predatory pricing are almost similar except in limit pricing the influential firm is trying to limit
the entry of new companies by setting very low prices that discourages new companies from
entering the market but they still some little profit. These actions by the incumbent companies
certainly act as barriers to free entry for any potential new company. (Vives, 1999) For instance
in the detergent industry in the U.K, only two players dominate the industry i.e. Unilever Procter
& Gamble. The two firms can agree to lock out other new players in the industry by adjusting the
prices of their products accordingly. (Datamonitor, 2008)
Economies of scale. If the incumbent firms are large they are most likely gaining from
economies of scale. By virtue of their sizes, there average production costs are lower and are
more flexible to adjust to market demands than the new firms that have smaller scales. The small
firms suffer a relative disadvantage because of their sizes and their new entry demands. These
disadvantages act as deterrent to new firms wishing to join the market.
Patents are rights over a product, item or something that after an application has been considered
and the inventor of the product is certified as the original inventor, the government registers the
product and grants the inventor or the company legal protection to produce the product without
competition for a stated period of time. Patents are awarded as incentives to encourage
Economics – Entry barriers to Oligopolistic Markets 5
innovations among individuals and companies. Patents act as barriers for companies willing to
join such markets. There are other legal barriers imposed by the government, for instance only
the Post office is allowed to sell postage stamps. (Pindyck & Rubinfeld, 2001)
Advertising and marketing; Large companies which are well established have enormous
advertising budgets that are literally unaffordable by small firms. These companies spend
millions of dollar in advertising expenses whose major objectives and aims are to create brand
loyalty. The brand name becomes the generic name for the product. For instance most people ask
for coke when they actually mean pepsi. A strong brand ensures steady sales for the product in
question but spells disaster for emerging firms or products trying to enter or expand into the new
market. (Samuelson & Marks, 2003)
The strength of mergers or vertically integrated companies. These are mergers where firms in
the same industry or different levels of production merge their companies or production
processes. These can either be backward or forward vertical integration. For instance when the
steel plant and the car manufacturing plant merge together, it will be difficult and expensive for
other car manufacturers to compete with such mergers. This creates a comparative advantage for
one company and creates a huge disadvantage for the other firms and may result in locking other
firms from the market. Companies that have merged successfully and currently dominate their
industries are like the PriceWaterhouseCoppers, Deloitte Touche Tohmatsu, Ernst and young and
KPMG dominates the accounting and auditing services in most parts of the world.
Experience economies; Established companies tend to have wide experience its operations and in
acquisition of raw materials and in its sales and marketing strategy. Well established restaurants
have mastered the seasonal nature of the hotel industry i.e. they are aware when to restock and
Economics – Entry barriers to Oligopolistic Markets 6
by how much and also when to hire more waiters. This experience is only gathered from the
industry. New players in the market may find it difficult to remain profitable under certain
conditions. (Melvin & Boyes, 2002)
Expensive and complex technology. The nature of the business may also act as a deterrent to
other firms from entering the market. The complex and expensive nature of some business firms
like the electricity sector may be difficult to establish and maintain any competition. (Merrill and
Schneider, 1966) Currently six companies dominates the electricity sector in the U.K, these are
EDF Energy, Centrica, RWE npower, E.on, Scottish Power and the Southern Energy. Between
themselves they control 99% of the total power consumption in the U.K. It’s very difficult for
other players to enter the electricity market as it’s well dominated and the recovery of the initial
funding will take make years to be repaid as the technology and development expenditure used is
massive and very complex in nature. (Archibald, 1992)
To conclude, Oligopolistic markets operate and thrive under competitive conditions that are
imperfect. Oligopolistic firms utilize all forms of non-price competition to create brand loyalty in
order to accumulate more revenue and greater market share.
Economics – Entry barriers to Oligopolistic Markets 7
References
Archibald, G. (1992) Information, Incentives and the Economics of Control . Cambridge, MA:
Cambridge UP.
Colander, C. (2008) Microeconomics. McGraw-Hill
Datamonitor (2008) Accountancy Industry Profile: Global Magazine
Datamonitor (2008) Textile Washing Products Industry Profile: United Kingdom. November
Hirschey, M. (2000) Managerial Economics. Dryden
Hicks, J. (1939) Value and Capital. An Inquiry into Some Fundamental Principles of Economic
Theory. 2nd ed. Glasgow: Oxford UP.
Kreps, D. (1990) A Course in Microeconomic. Princeton.
Melvin & Boyes, (2002) Microeconomics. Houghton Mifflin
Merrill, W. and Schneider, N (1966) Government Firms in Oligopoly Industries.
Quarterly Journal of Economics .
Mundell, R. (1968) Man and Economics. New York: McGraw-Hill.
Negbennebor, A. (2001) Microeconomics: The Freedom to Choose.
Pindyck, R. & Rubinfeld, D. (2001) Microeconomics. Prentice-Hall.
Samuelson, W & Marks (2003) Managerial Economics. Wiley
Vives, X. (1999) Oligopoly pricing, Cambridge MA. MIT Press
Economics – Entry barriers to Oligopolistic Markets 8
Wiens, E. (1978) A Positive Theory of Government Firm Regulation .
UCLA Economics: Working Paper #134
