Oligopoly market structure exists where there are a small number of large firms dominating the market.
- Retail banks
- Mobile phone networks
Characteristics of Oligopoly market structure
- High concentration ratio
- High barriers to entry
- Firms are interdependent (They make price and output decisions based on each others)
- Firms compete through non – price competition
Kinked demand curve
The kinked demand curve explains how an oligopolistic market functions theoretically.
- In an Oligopolistic market firms have no incentive to charge higher prices then PE.
- If one firm was to try and charge a higher price of P1 for a good or service. This would lead to them losing market share as the other firm would keep its price lower at PE.
- Oligopolistic firms are also unable to charge lower prices than competitors at P2. This is because if one firm lowers its price. The other firm will also lower its price below its competitors. This will lead to a price war where both firms continue to decrease their prices competing away their profit margins.
- Therefore firms will generally constrain themselves from lowering or increasing prices from PE in an oligopolistic market.
- Competing firms will therefore keep their prices at the same point PE, QE. This is known as the point of sticky prices.
- They will opt to compete with each other through non-price competition e.g. advertising, branding, packaging, after sales service etc.
- Firms are also most likely to collude at point PE, QE. This is because they are both able to earn higher profits if they were to increase their prices together without getting caught by regulators.
Collusion occurs when two or more firms price fix and restrict their outputs to the detriment of customers welfare.
Types of collusion
This is the type of collusion that occurs through ‘unspoken’, ‘quite’, ‘hidden’ agreements between two parties. They are often implicit agreements that are extremely difficult for competition authorities to prove. Tacit collusion is illegal.
Overt means open or spoken collusion between firms. They will both be aware of each other’s price and output decisions and adjust accordingly to maximise profits. This type of collusion is easier to detect and is also illegal.