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Characteristics of Oligopoly
- A few large producers
Usually three, four, or five firms occupy the market, e.g. "Big Three" in the U.S. aluminum industry and companies such as Nokia or Motorola in the cell phone industry, as well as companies in the video game console market. The four largest firms in the market occupy greater than 40% of the market.
- Homogenous OR differentiated products
Some oligopolistic industries offer homogenous, or standardized, products, e.g. those of steel, zinc, copper, lead, industrial alcohol. Other industries, e.g. those of automobiles, tires, electronics, breakfast cereal, offer different products and place an emphasis on nonprice competition, such as advertising.
- Price maker, but still mutually interdependent
The small number of firms let oligopolies to set prices and output levels, to some extent. However, because there are rival firms, oligopolies must take note at how they react to its change in price, output, product or advertising.
- Strategic Behavior: self-interested behavior that takes into account the reactions of others
- Mutual interdependence: profit doesn't depend entirely on its own price and strategies
- Relatively high entry barriers
Entry barriers exist that allow a handful of firms to achieve economies of scales, but no more beyond that. Any new firms would have too small a market share and would have to produce at too high a price. Sometimes the cost of capital is too high and other times, ownership and control of the raw materials is a factor. Patents and brand loyalty are also barriers of entry into an oligopolistic market.
- While many oligopolies have emerged through the growth of dominant firms in a certain industry, many have also emerged through mergers.
- Ex.steel, airlines, banking, and entertainment industries
- Merging of two or more competing firms is beneficial in that it may increase their market share significantly, and thus achieve greater economies of scale. In this way, competition can also be reduced.
- Firms may also merge hoping to achieve monopoly power.
- The larger firm that results from a merger would have greater control over market supply and price than a few smaller firms.
Measures of Industry Concentration
- Attempts to measure market dominance
- Price Leadership is when one firm has a dominant position in the market.
- That firm will set a market price and firms with lower market shares will follow the change.
The Four Firm Concentration Ratio
- Is the scale that determines whether a industry is monopolistic competition or oligopoly. If the combination of market share of the four largest firm in a single industry is equal or greater than 40%, the industry is consider as oligopoly.
- A concentration ratio reveals the percentage of total output produced and sold by the industry's largest firms
- The HHI measures of the number and size of firms in ratio to the industry. It serves as an indicator of the amount of competition within a market. It is defined as the sum of the squares of the market shares of each individual firm.
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