Oligopoly is a situation where a few large firms compete against one another and are interdependent with respect to decision making.
Characteristics
- There are small number of large sellers.
- The product they sell can be differentiated or homogeneous.
- The policies of each seller have a noticeable impact due to the extent of influence of each seller.
- The element of interdependence.
- Cross elasticity of demand is very high due to the close substitutes of the product.
- Existence of price rigidity.
- The firms may enjoy some monopoly power.
- Strategies available to an oligopolist include advertising, quality improvement, etc. as the firms suffer from rigidity of prices.
- Oligopoly can be classified as perfect and imperfect oligopoly on the basis of product differentiation, open or closed oligopoly on the basis of entry of firms, partial or full depending upon presence or absence of market leader.
- When the firms follow a common price policy, it is known as collusive oligopoly.
Strategy
Because of the element of interdependence, oligopolist market is characterised by price wars. The oligopoly firms may decide to collude in order to avoid price wars. In a cartel, firms collude in setting prices and output levels. The necessary conditions for collusion include:
- Control of firms on supply in the market.
- Not a very price elastic product.
- Mechanism to detect and punish cheaters among the firms.
MRTP Laws do not allow collusion and collusion would result in higher price. Because each firm has an incentive to secretly lower its prices and expand its market share, no firm would like to change its price resulting in the rigidity of prices. Implicit collusion in the form of price leadership may be done by the oligopolisitic firms.
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