There does not, however, have to be a formal agreement for collusion to take place. For example, in some industries, there may be an acknowledged market leader which informally sets prices to which other producers respond, known as price leadership, which is a form of Tacit Collusion. Only when communication takes place between companies is the act illegal.
Oligopolists believe that if they raise their prices, other firms in the same industry will not as they will gain customers from them, but if they cut their prices, so will all other firms as to prevent losing customers to them. The kinked demand curve model below shows this.
The demand curve is kinked at the current price P1. A small price rise above P1 leads to a big fall in quantity demanded as the firm loses its market share to other firms that do not raise prices. So the demand curve is relatively elastic above P1. A large price cut below P1 only leads to a small increase in quantity. In this case, other firms match the price cut, so the firm gets very little price advantage over its competitors. So demand is relatively inelastic below P1.
In other situations, competition between sellers in an oligopoly can be fierce, with relatively low prices and high production. This could lead to an efficient outcome approaching perfect competition.
When oligopolies need to be defined in a quantitative way, the four-firm concentration ratio is often used. This ratio puts across the market share of the four largest firms in an industry as a percentage. When this measure is used, an oligopoly is defined as a market in which the four-firm concentration ratio is above 40%. An example would be the supermarket industry in the United Kingdom, with a four-firm concentration ratio of over 70%1 and the brewery industry also in the U.K has a concentration ratio of a staggering 85%1.
It is said that analysing the behaviour of firms in oligopolistic markets is extremely difficult as each company will be aware that whatever action it takes will most likely result in a reaction from competitors. Therefore it must attempt to take this reaction into account before undertaking anything (Line/Marcousé/Martin 2003).
As mentioned before, the supermarket industry and the brewery industry would be examples of oligopolistic industries, but there are many others. The mobile phone network industry, for instance, could be defined as operating in an oligopoly, with O2, Vodafone, Orange and T-Mobile being the main companies in that market.
But to what extent does the behaviour of the firms in the industries identified correspond to that description of an oligopolistic industry defined above?
Following on from the supermarket industry example, Tesco, for instance, is an example of an oligopolistic behaving firm to some extent. The company doesn’t just sell food and groceries at its stores, it has now expanded its product range so that it sells products ranging from bread to DVD players, and from low-price high-quality clothes (following Asda’s success in this area) to car insurance. This sort of behaviour is following the theory set out above about behaviour of firms in oligopolistic industries. The firm is pursuing this strategy in order to achieve product differentiation, and therefore remain competitive in an industry where competition is intense.
The other remaining firms are attempting to imitate this approach to tackle Tesco’s market leader position, and so that their own market share is not affected. This highlights another similarity with the oligopoly behaviour theory. The fact that other companies in the industry are trying to imitate Tesco, shows that they are interdependent of each other. Furthermore, with Tesco and Asda having the same discount strategies it suggests once more that they are interdependent.
Another similarity with the theory is the recent merging of the two other supermarkets, Morrisons and Safeway. Merging is one of the best ways to expand a company in a market with fierce competition such as the supermarket industry, and so is typical behaviour in an oligopolistic industry. This is due to the fact that there is little room for organic growth (growth from inside the firm, not from acquiring or merging) and so the only other option is grow externally i.e. through acquiring or merging.
However, over the last few years, there has been much publicity over the rivalry between Tesco and Asda, the two market leaders in the industry, regarding the price war that exists between them. More recently, after merging with Safeway, Morrisons has become a third entrant in the price war. This sort of behaviour by these companies is not how the theory suggested, as they are competing on price. Tesco is taking this price war so seriously, and so determined to stand for price leader, it places cards around its stores listing the prices of its goods compared to competition.
It is evident now that even though a particular industry can be defined as an oligopoly, the firms within that industry do not necessarily behave as is assumed. The extent to which firms do behave as described in the theory will obviously depend on the industry concerned, and oligopolistic behaviour will be greater in some industries, e.g. the construction industry or the chemicals/oils industries, than others.
References:
Complete A-Z Business Studies Handbook 4th Edition
Authors: David Line/Ian Marcousé/Barry Martin
Year of Publication: 2003
Name and place of publisher: Hodder and Stoughton, London
www.tutor2u.net Last Visited: 10/01/06
www.amosweb.com Last Visited: 10/01/06
www.bized.ac.uk Last Visited: 10/01/06
http://en.wikipedia.org Last Visited: 10/01/06
www.oligopolywatch.com Last Visited: 11/01/06
1Source: http://en.wikipedia.org Adam Bates
