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Monday, February 20, 2012

Oligopoly

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I consider how a firmfs competition may strategically react to the decisions of the firm, and changes in the marketplace. To illustrate how different types of competition affect industry profits, I will look at a market structure oligopoly which is much more difficult to evaluate than other market structure. It is important to realize that most real world industries engage in many different types of competition simultaneously. This paper will provide information to answer the questionh Why is oligopolistic collusion more difficult when there is product variation than when the products of all firms are identical?h


About Oligopoly


Oligopoly is defined as an industry in which there are a few firms. By a few it is meant that the number of firms should be sufficiently small for there to be conscious interdependence, with each firm aware that its future prospects, depend not only on its own policies, but also those of its rivals. An industry is defined as a group of firms where the firms products are close substitutes for one another, that is have a high and positive cross elasticity of demand


There are three-models in oligopoly such as collusion, price leadership, and Kinked demand curve. In this paper, I will focus on the collusion model (the cartel model), and then explain the collusion model.


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Collusion and Cartels


When an oligopoly is non-collusive the firm uses guesswork and calculation to handle the uncertainty of its rivals reactions. However another way of handling uncertainty in markets which are interdependent is by some form of central co-ordination. One form of collusion is to form a cartel. A cartel is the establishment of some central body with responsibility for setting the industry price and output. Collusion is illegal in the U.S. but cartels such as oil producers are active in other parts of the world. However, in the U.S. many firms have been investigated for collusive behavior. An estimated percent of firms in the U.S. have admitted to or have been convicted of illegal price fixing. When firms engage in collusion they may agree on prices, market share, and advertising expenditure. The cartel will maximize profits if it behaves as a monopoly. Having agreed on the cartel price the members may then compete against each other using non-price competition to gain a bigger share of output or they may somehow decide to share the market between them


Equilibrium in an Oligopolistic Market


In any market, firms are in equilibrium when they are doing the best they can and have no reason to change their price or output. Since firms in an oligopoly market have the knowledge of their competitors, oligopoly firms are in equilibrium when they do their bests given what their competitors are doing.


Since it is true for any firm, the competitors also will do their best given the actions of said firm.


Differentiated and Homogeneous product


There are two types of oligopoly, impure oligopoly that has a differentiated product, and pure oligopoly that has a homogeneous product. Homogenous product means that product the company is producing is identical with any other same product that different company is producing. These products are usually not as many as differential products for example gasoline, steel, gold, wheat, and so on. There are all homogenous products because there are very few differences among them. While homogenous products are almost identical, differential products are all the other products any company is producing and even when products are similar in many ways there still can be lots of differences between each product. Differentiated products make the firmsf coordination problem more complex. An increase in the product differentiation leads to a decrease in the correlation of the demand functions for goods. In an environment where a firm cannot observe its competitorsf action, but they have to infer from observable signals whether another firm has deviated. This makes oligoplistic collusion more difficult to sustain. Product differentiation limits the scope of oligoplistic collusion or the cartel model. Because with a lower correlation, discrimination between cheating and exogenous fluctuations in demand is more difficult. Therefore, there is the effect of a deviation on the probability of a price war. That can weaken the stability of the oligoplistic collusion. In the traditional view, product variation impedes cartel behavior because firms meet a situation of high complexity. For instance, firms merely have to agree on one price when the products of all firms are identical, but firms have to negotiate the prices when the products of all firms are different. Furthermore, firms may have difficulty in monitoring the policies of their competitorsf in complex situations.


Conclusion


Under these circumstances, both the benefit of collusion and the gain of deviating from a cartel strategy are likely to be smaller for differentiated goods than for homogeneous goods. They show that product heterogeneity is a factor hindering collusion among oligoplists, because it entails a situation of higher gcomplexityh than prevails with homogeneous goods. That explains why oligoplistic collision is more difficult when there is product variation than when the products of all firms are identical.


References


Tucker, I. B. (000), Market structures; Monopolistic competition and oligopoly, Economic for Today. South-Western College Publishing.


http//www.missouri.edu/~auras/51files/lectures-4.pdf


Retrieved February 1, 00


http//people.moreheadstate.edu/fs/m.phillips/micronoteschap111.pdf


Retrieved February 1, 00


http//www.genconnection.com/econ/chapter10-11.htm.


Retrieved February 1, 00





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