Oligopoly
Few firms; strategic interaction.
Note: HL-only content. Skip if SL only.
Oligopoly — a market with a small number of large firms whose actions affect each other.
Key features:
- Strategic interdependence — each firm's price/output affects rivals' decisions.
- High barriers to entry (capital requirements, brand loyalty, patents, economies of scale).
- Differentiated or homogeneous products possible.
- Examples: smartphones (Apple, Samsung, Google), aviation (Boeing, Airbus), oil majors, soft drinks (Coca-Cola, Pepsi).
Competing models:
Kinked demand curve — explains price rigidity. Firms believe:
- If they RAISE price, rivals WON'T follow → lose market share → demand elastic above current P.
- If they LOWER price, rivals WILL follow → no gain in share → demand inelastic below current P.
- Net: demand curve KINKED at current price; firms reluctant to change price.
Game theory and the prisoner's dilemma. Firms choose between cooperation (collude to raise prices) and defection (cut price for market share).
- Both cooperating = high industry profit.
- Both defecting = competitive outcome, low profit for both.
- One cooperates, one defects = defector gains a lot, cooperator loses.
- Each firm's DOMINANT strategy = defect → both end up worse off than if they'd cooperated.
Collusion — formal (cartel, like OPEC) or tacit (implicit understanding). Illegal in most countries because it raises prices and reduces consumer welfare.
Oligopoly outcomes:
- High prices, restricted output.
- Non-price competition (advertising, R&D, product differentiation).
- Risk of collusion.
Monopoly — a SINGLE firm dominates the market.
Causes (barriers to entry):
- Legal barriers — patents, copyrights, licences.
- Natural monopoly — production technology (high fixed cost; LR average cost falls as output rises). Examples: rail networks, water utilities.
- Economies of scale — incumbents have cost advantages.
- Control of essential resources — De Beers historically with diamond mines.
- Network effects — value depends on number of users (search engines, social media).
Monopoly outcomes:
- Profit-max at MR = MC.
- P > MC → allocative inefficiency.
- Possible X-inefficiency (slack management) due to no competitive pressure.
- Potential for price discrimination (charge different prices to different consumers).
- Long-run supernormal profit.
Pros of monopoly:
- Economies of scale lower costs.
- Profits can fund R&D and innovation (Schumpeter's argument).
- Natural monopolies avoid duplication waste.
Policy responses:
- Antitrust law — prevent mergers that reduce competition; break up monopolies (e.g. AT&T 1984, Standard Oil 1911).
- Regulation — price caps, quality standards, especially for natural monopolies.
- Public ownership — government runs the monopoly (e.g. national rail, water).
- Promote competition — reduce barriers, allow new entrants.
- Oligopoly: few firms, strategic interaction.
- Kinked demand → price rigidity.
- Game theory + collusion incentives.
- Monopoly: single firm; barriers to entry.
- Policy: antitrust, regulation, public ownership.