Oligopoly defines a market structure where there are only a few producers. Such a market refers to a situation where a small number of large firms offer products to a large number of buyers, and these firms are influenced by each other's decisions. The theory of oligopoly is an important part of microeconomic theory, examining the effects of this market structure on prices, production quantities, and firms' strategic decisions. Oligopoly typically lies between perfect competition and monopoly market structures, where firms are interdependent, and prices and production quantities are determined through mutual interaction.
History and Development
The term "oligopoly" was first used in the 16th century by Thomas More in Latin as oligopolium. However, its widespread use as an economic term dates back to 1933. The American economist Edward Chamberlin introduced the term to economics, using it to describe a market controlled by a small number of firms. The English word "oligopoly" is derived from the Ancient Greek olígos (few) and pōlíon (seller), with pōlíon being derived from the verb pōléō (to sell). Over time, this concept began to be used to describe market structures such as monopolies and oligopolies.
The foundations of oligopoly theory were laid in the 19th century by French economist Augustin Cournot. In his 1838 work, Cournot examined oligopoly markets, explaining how firms in these markets react to each other's production decisions. Cournot's work provided the first systematic analysis of oligopoly theory and was later developed by many economic theorists. After Cournot, various models were proposed to explain the behavior of firms in oligopoly markets. These models include Cournot's model, as well as those of Bertrand, Edgeworth, Chamberlin, and Sweezy.
Basic Characteristics of Oligopoly Markets
The key feature of oligopoly markets is the presence of a small number of firms active in the market. These firms make decisions based on the strategic moves of their competitors. In oligopolies, firms are involved in interactions regarding production quantities, prices, and other strategic decisions. This interaction leads each firm to consider the actions of its competitors when determining its price and production level. In oligopoly markets, prices are expected to form below the monopoly price. The reason for this is that as the number of firms increases, competition tends to lower prices. However, in oligopoly markets, due to the strategic decisions of firms, prices may be higher than in perfectly competitive markets.
Cournot Model
The Cournot model is one of the first and most fundamental models of the oligopoly market structure. This model assumes that two competing firms determine their production quantities, assuming that the production quantities of their competitors are fixed. Cournot developed his model with two firms that produce homogeneous products and operate with no cost. One of the model’s key assumptions is that each firm seeks to maximize its profit, but it assumes that its competitor’s production quantity remains fixed. According to the Cournot model, as the number of firms increases, prices decrease, and the market price forms below the monopoly price. This model has formed an important foundation for understanding the dynamics of oligopoly markets.
Sweezy Model (Kinked Demand Curve Model)
The Sweezy model is another important theory that explains price stability in oligopoly markets. Sweezy argued that if an oligopoly firm lowers its prices, competing firms will also lower their prices, but if it raises its prices, competitors will not follow the price increase. This results in a kinked (non-linear) demand curve. In Sweezy’s model, when a firm lowers its prices, other firms follow by lowering their prices as well, maintaining competition, but if a firm raises its prices, other firms will not increase their prices, and the firm faces the risk of losing market share. This model explains why prices in oligopoly markets generally remain stable and why price stability is maintained.
Cartels and Agreements in Oligopoly Markets
In oligopoly markets, firms can often enter into explicit or tacit agreements. These agreements may involve fixing prices, limiting production quantities, and dividing markets. A cartel is an agreement among firms to fix prices, restrict production quantities, and share markets. By limiting the independent decision-making authority of its members, a cartel allows firms to act like a single monopolistic firm. There are three main types of cartel agreements: price cartels, quantity cartels, and regional cartels.
Applications of Oligopoly Theory
Oligopoly markets reflect many real-world industries. Such markets are often seen in sectors like oil companies, automobile manufacturers, banks, and telecommunications. Oligopolistic market structures limit the entry of new firms into the market, allowing existing firms to maintain their market share. Furthermore, in these markets, firms focus on product differentiation and marketing strategies instead of price competition. Firms make decisions based on their competitors' strategic moves and seek to gain a competitive advantage by offering new products and services.
