Understanding Oligopoly Market Structures & Models

Oligopoly

In oligopolistic markets, products may or may not be differentiated. What matters is that only a few firms produce most or all of the total output. Some or all oligopolistic market firms often earn significant returns over time because barriers to entry hinder or prevent the entry of others. An oligopoly is a widespread type of market structure, for example, in vehicle manufacturing.

These barriers to entry are often natural, meaning they are fundamental to the market structure. However, existing firms in the market may also take strategic actions to deter others from entering.

Managing an oligopolistic company is complicated because decisions regarding prices, advertising, and production involve major investment and strategic considerations. As only a few firms compete, each must carefully consider the influence of its actions on its rivals and their possible reactions. Barriers can also be strategic, arising when firms make decisions while anticipating their competitors' reactions, knowing that their own actions will also be anticipated by rivals.

Market Equilibrium in Oligopoly

When the market is in balance, companies achieve the best possible results and have no reason to alter their price or production levels. Therefore, a competitive market is in balance if quantity supplied is equal to demand: each company achieves the best possible results.

The Nash Equilibrium

The Nash equilibrium is a set of strategies or actions with which each firm achieves the best possible results, given the actions of its competitors. Markets in which only two companies compete are called duopolies. Each firm, therefore, only has to consider one competitor's decisions.

Oligopoly Models

• The Cournot Model

  In the Cournot model, each company considers the output level of its competitor as fixed and then decides the amount it will produce. A reaction curve is the relationship between the output level that maximizes an enterprise's benefits and the amount its competitor is believed to produce. Cournot equilibrium is a state where each firm correctly assumes the output level of its competitor and sets its own production level accordingly.

• The Stackelberg Model

  This duopoly model differs from Cournot in that one firm acts as a leader, setting its output level before the other, which then reacts. It is an oligopoly model in which one company sets the level of output before the rest.

• The Bertrand Model (Price Competition with Homogeneous Goods)

  This is an oligopoly model where firms producing a homogeneous good compete on price, each firm setting its price assuming the competitors' prices are fixed.

Cartels

Producers in a cartel expressly agree to cooperate to fix prices and production levels. Not all producers in an industry must join a cartel, but if a significant number of producers accept the cartel's resolutions and if market demand is sufficiently inelastic, the cartel may raise prices well above competitive levels.