Oligopoly: Characteristics and Models

Oligopoly: characteristics and models
Oligopoly is a market of several large sellers. The key feature is interdependence: each firm’s decision depends on the expected actions of competitors. This makes analysis more complex than for other structures.

Characteristics of Oligopoly

1. Small number of firms:

   • Usually 2–10 major players
   • Each holds a significant market share
   • Actions of one affect the others

2. Interdependence (Strategic interdependence):

   • Firms take into account the reaction of competitors
   • "If I lower my price—what will they do?"
   • Game theory is an analytical tool

3. Barriers to entry:

   • Substantial—otherwise, there would be more firms
   • Economies of scale, capital, brands

4. Product—homogeneous or differentiated:

   • Homogeneous: oil, steel, aluminum
   • Differentiated: automobiles, air transportation

Examples of oligopolies

• Automobiles: Toyota, VW, GM, Ford, Honda...
• Telecom: 3–4 operators in most countries
• Aviation: several major carriers
• Oil: ExxonMobil, Shell, Chevron, BP...
• Tech: Apple, Google, Microsoft, Amazon
• Banks: a few systemically important institutions

Models of Oligopoly

There is no single model—different assumptions about behavior:

Cournot Model:

• Firms compete on quantity
• Each chooses its output, taking rivals’ quantities as given
• Nash equilibrium: no one wants to change their choice
• Result: between monopoly and competition

Bertrand Model:

• Firms compete on price
• With a homogeneous product: price falls to MC
• "Bertrand paradox": even two firms = competitive outcome
• With differentiated products: prices are above MC

Stackelberg Model:

• Leader-follower
• Leader chooses first, knowing the reaction of the follower
• Leader gains an advantage

Kinked Demand Curve

• Idea: firms do not react to a competitor’s price increase (their customers leave), but do react to a price decrease (so as not to lose their own).
• Result:
  • The demand curve "kinks" at the current point
  • MR has a discontinuity
  • Price remains stable even as costs change
• Explains: price rigidity in oligopolies.
• Criticism: does not explain how the initial price was set.

For the Investor

Oligopolies are often attractive:

• High barriers protect profits
• Price discipline (if pricing wars do not occur)
• Stable competitive structure

Risks:

• Price wars can destroy margins
• Antitrust regulation
• Disruption from new technologies

Key question: how do firms compete—on price or on other parameters?
Price competition is destructive.