BREAKING DOWN 'Oligopoly'

An example of an oligopoly is the wireless service industry in Canada, in which three

companies Rogers Communications Inc (RCI), BCE Inc (BCE) subsidiary Bell and
Telus Corp (TU) control approximately 90% of the market. Canadians are conscious of
this oligopolistic market structure and often lump the three together as "Robelus," as
though they were indistinguishable. In fact, they are often indistinguishable in price: in
early 2014 all three companies raised the price for smartphone plans to $80 in most
markets, more or less in tandem.
This example shows that participants in oligopolies are often able to set prices, rather
than take them. For this reason oligopolies are considered to be able increase profit
margins above what a truly free market would allow.
Most jurisdictions have laws against price fixing and collusion. An oligopoly in which
participants explicitly engage in price fixing is a cartel: OPEC is one example. Tacit
collusion, on the other hand, is perhaps more common though more difficult to detect. A
stable oligopoly will often have a price leader; when the leader raises prices, the others
will follow.
The alternative is for one or more firms to take advantage of the price rise by cutting
prices and siphoning business away from the company with the highest price. If that
happens, firms may align in a number of different ways: the majority may keep prices
low in an attempt to squeeze the firm with the highest price out of the market; the
majority may raise prices, isolating the "cheating" firm and putting it under financial
strain; or they may each attempt to undercut the rest, setting off a price war that could
damage them all. The late 19th-century railroad cartel in the U.S. was characterized by
blatant collusion and price fixing, interspersed with vicious price wars.
Game theorists have developed models for these scenarios, which form a sort
of prisoner's dilemma. In general, a situation of (tacit) collusion on prices is considered
to be the Nash equilibrium state for oligopolies. Rather than using price, firms in
oligopolies tend to prefer to use product differentiation, branding and marketing to
compete, with the goal being to increase market share.
The reason new entrants seldom come in to disrupt the market is that oligopolistic
industries tend to have high barriers to entry. Wireless carriers, for example, must either
build and maintain towers, requiring massive capital expenditures, or lease the
incumbents' infrastructure at vampiric rates. Carriers also tend to have strong, instantly
recognizable brands. Even if these brands carry certain negative associations (ie,
"cartel"), they provide a distinct advantage over unknown new entrants. Other industries
that have commonly seen oligopolies also have high barriers to entry: oil and gas
drillers, airlines, grocers and movie studios are a few examples.

Characteristics

Single Seller: In a monopoly there is one seller of the monopolized good who
produces all the output.[3] Therefore, the whole market is being served by a single
firm, and for practical purposes, the firm is the same as the industry. In a
competitive market (that is, a market with perfect competition) there are an
infinite number of sellers each producing an infinitesimally small quantity of
output.

Market Power: Market Power is the ability to affect the terms and conditions of
exchange so that the price of the product is set by the firm (price is not imposed
by the market as in perfect competition).[4][5] Although a monopoly's market power
is high it is still limited by the demand side of the market. A monopoly faces a
negatively sloped demand curve not a perfectly inelastic curve. Consequently,
any price increase will result in the loss of some customers

Monopolies derive their market power from barriers to entry - circumstances that
prevent or greatly impede a potential competitor's entry into the market or ability to
compete in the market. There are three major types of barriers to entry; economic, legal
and deliberate.[6]

Economic Barriers:Economic barriers include economies of scale, capital

requirements, cost advantages and technological superiority.[7]

Economies of scale: Monopolies are characterized by declining costs over a relatively

large range of production.[8] Declining costs coupled with large start up costs give
monopolies an advantage over would be competitors. Monopolies are often in a position
to cut prices below a new entrant's operating costs and drive them out of the industry. [8]
Further the size of the industry relative to the minimum efficient scale may limit the
number of firms that can effectively compete within the industry. If for example the
industry is large enough to support one firm of minimum efficient scale then other firms
entering the industry will operate at a size that is less than MES meaning that these
firms cannot produce at an average cost that is competitive with the dominant industry.
Capital requirements: Production processes that require large investments of capital,
or large research and development costs or substantial sunk costs limit the number of
firms in an industry.[9] Large fixed costs also make it difficult for a small firm to enter an
industry and expand.[10]

Technological Superiority: A monopoly may be better able to acquire, integrate and

use the best possible technology in producing its goods while entrants do not have the
size or fiscal muscle to use the best available technology.[8] In plain English one large
firm can sometimes produce goods cheaper than several small firms. [11]
No Substitute Goods:A monopoly sells a good for which there is no close substitutes.
The absence of substitutes makes the demand for the good relatively inelastic enabling
monopolies to extract positive profits.

Control of Natural Resources: A prime source of monopoly power is the control

of resources that are critical to the production of a final good.

Legal Barriers: Legal rights can provide opportunity to monopolize the market in
a good. Intellectual property rights, including patents and copyrights, give a
monopolist exclusive control over the production and selling of certain goods.
Property rights may give a firm the exclusive control over the materials necessary
to produce a good.

In addition to barriers to entry and competition, barriers to exit may be a source of

market power. Barriers to exit are market conditions that make it difficult or expensive
for a firm to leave the market. High liquidation costs are a primary barrier to exit. [12]
Market exit and shutdown are separate events. The decision whether to shut down or
operate is not affected by exit barriers. A firm will shut down if price falls below minimum
average variable costs.
1.4 Monopoly versus competitive markets
While monopoly and perfect competition mark the extremes of market structures [13] there
are many point of similarity. The cost functions are the same. [14] Both monopolies and
perfectly competitive firms minimize cost and maximize profit. The shutdown decisions
are the same. Both are assumed to face perfectly competitive factors markets. There
are distinctions, some of the more important of which are as follows:
Market Power - market power is the ability to control the terms and condition of
exchange. Specifically market power is the ability to raise prices without losing all one's
customers to competitors. Perfectly competitive (PC) firms have zero market power
when it comes to setting prices. All firms in a PC market are price takers. The price is
set by the interaction of demand and supply at the market or aggregate level. Individual
firms simply take the price determined by the market and produce that quantity of output
that maximize the firm's profits. If a PC firm attempted to raise prices above the market
level all its "customers" would abandon the firm and purchase at the market price from
other firms. A monopoly has considerable although not unlimited market power. A
monopoly has the power to set prices or quantities although not both. [15] A monopoly is a

price maker.[16] The monopoly is the market[17] and prices are set by the monopolist
based on his circumstances and not the interaction of demand and supply. The two
primary factors determining monopoly market power are the firm's demand curve and its
cost structure.[18]
Product differentiation: There is zero product differentiation in a perfectly competitive
market. Every product is perfectly homogeneous and a perfect substitute. With a
monopoly there is high to absolute product differentiation in the sense that there is no
available substitute for a monopolized good. The monopolist is the sole supplier of the
good in question.[19] A customer either buys from the monopolist on her terms or does
without.
Number of competitors: PC markets are populated by an infinite number of buyers
and sellers. Monopoly involves a single seller.[19]