Oligopoly in Practice

1. Legal Frame work ▫Antitrust policy  This involves the efforts by the government to prevent oligopolistic industries from becoming or behaving like monopolies.  Example: earliest example of this came in 1911 when Standard Oil was split up.  Another example was in the 1980s with Bell Telephone. ▫Had a monopoly on both local and long distance phone service.  Also keep in mind the Justice Department can and do review proposed mergers between companies in the same industry.

2. Tacit Collusion and Price Wars ▫Large Numbers  The more firms there are in oligopoly, the less is the incentive of any one firm to behave cooperatively, taking into account the impact of its own actions on the profits of the other firms.  Large numbers of firms also makes monitoring of price and output levels more difficult and typically indicate low barriers to entry.

▫Complex Products and Pricing Schemes  Also remember in reality oligopolists sell thousands or even tens of thousands of different products. (i.e. Wal-mart Super Center sells over 100,000 items).  Under these circumstances keeping track of what other firms are producing and what prices they are charging is difficult.

▫Differences in Interests  Firms often differ both in their perceptions about what is fair and in their real interests. ▫Bargaining Power of Buyers  Often oligopolists sell not to individual consumers but to large buyers.  This puts the large buyers in a position to bargain for lower prices.  Because tacit collusion is often hard to achieve, most oligopolies charge prices that are well below what the same industry would charge if it were controlled by a monopolist  Sometimes tacit collusion breaks down and aggressive price competition amounts to a price war.  Price war occurs when tacit collusion breaks down and aggressive price competition causes prices to collapse.

3. Product differentiation and Price Leadership ▫ Product Differentiation  Many firms in oligopolies produce products that customers regard as similar but different.  The effect of this is not all customers will rush to buy whatever product is cheapest.  Oligopolists welcome the extra market power that comes when customers think their product is different from their competitors.  This cause many oligopolists to engage in product differentiation ◦It is an attempt by a firm to convince buyers that its product is different from the products of other firms in the industry.

 A classic example of how products may be perceived as different even when they are really pretty much the same is over-the-counter medication.  Whatever the nature of product differentiation, oligopolists producing differentiated products often reach a tacit understanding not to compete on price.  Example: the top three car manufacturers in the early days of automobiles. ▫Each company had a tacit understanding and did not lower price to gain customers. ▫However one company sets prices and the others would set similar prices. ▫This pattern of behavior where on company tacitly sets price for the industry as a whole is known as price leadership.

 Firms that have a tacit agreement not to compete on price often engage in vigorous nonprice competition.  They add new features to their products, spending large sums on ads that proclaim the inferiority of their rivals’ offerings  Best example to understand the mix of cooperation and competition in such industries is with a political analogy: The Cold War