An oligopoly is a market structure in which there are a few, large firms that participate in non-price competition. Oligopolies differ from monopolistically competitive markets in that there are high barriers to entry. Products can be either homogeneous, differentiated, or both. Interdependence is also a key characteristic of oligopolies. Because the market is controlled by a small number of dominant firms, any single action taken by a firm has major repercussions on the market. If, for example, one firm reduces increases output or reduces the price of their goods, this change will be noticed by other firms and will cause a reaction. This interdependence causes the kinked demand curve
Thus, in an oligopoly, firms are reluctant to compete with price. Non price competition is prevalent because of this. Firms can compete through: quality and innovation of products, perceived value of products, and branding and advertising. Quality and innovation occur when research and investment happens. This can occur because like monopoles, oligopolies can achieve abnormal profits. Perceived value rewards customers for using the product and effectively allows oligopolies to compete without explicitly changing prices by instead, increasing value to products beyond their inherent utility. Reward programs, discounts, customer service/warrantees are all examples of ways to increase perceived value of a product. Finally, oligopolies spend considerable amounts of money on advertising in order to establish brand loyalty.
The nature of interdependence however may cause oligopolies to collude. In a market, firms have a choice between competing or colluding, that is when firms in an oligopoly agree to cooperate in establishing prices, output, or other aspects of their firm. The reason for this with price, is obvious and demonstrated by the kinked demand curve, it could result in a price war. Other forms of competition can result in hurting all firms too though, such as advertising wars that cause higher prices for all firms. Therefore, oligopolies have incentive to collude. However game theory illustrates how collusive firms also have incentive to cheat.
Cartels are extreme versions of collusive oligopolies. Cartels often operate internationally, as price-fixing may be illegal. Participants in cartels also have incentive to cheat.
Thus, in an oligopoly, firms are reluctant to compete with price. Non price competition is prevalent because of this. Firms can compete through: quality and innovation of products, perceived value of products, and branding and advertising. Quality and innovation occur when research and investment happens. This can occur because like monopoles, oligopolies can achieve abnormal profits. Perceived value rewards customers for using the product and effectively allows oligopolies to compete without explicitly changing prices by instead, increasing value to products beyond their inherent utility. Reward programs, discounts, customer service/warrantees are all examples of ways to increase perceived value of a product. Finally, oligopolies spend considerable amounts of money on advertising in order to establish brand loyalty.
The nature of interdependence however may cause oligopolies to collude. In a market, firms have a choice between competing or colluding, that is when firms in an oligopoly agree to cooperate in establishing prices, output, or other aspects of their firm. The reason for this with price, is obvious and demonstrated by the kinked demand curve, it could result in a price war. Other forms of competition can result in hurting all firms too though, such as advertising wars that cause higher prices for all firms. Therefore, oligopolies have incentive to collude. However game theory illustrates how collusive firms also have incentive to cheat.
Cartels are extreme versions of collusive oligopolies. Cartels often operate internationally, as price-fixing may be illegal. Participants in cartels also have incentive to cheat.