An oligopoly (from Ancient Greek (olgos), meaning "few", and (polein), meaning "to sell") is a market

form in which a market or industry is dominated by a small number of sellers (oligopolists). Oligopolies can result
from various forms of collusion which reduce competition and lead to higher prices for consumers. Oligopoly has its
own market structure.[1]
With few sellers, each oligopolist is likely to be aware of the actions of the others. According to game theory, the
decisions of one firm therefore influence and are influenced by decisions of other firms. Strategic planning by
oligopolists needs to take into account the likely responses of the other market participants.

Profit maximization conditions

An oligopoly maximizes profits.
Ability to set price
Oligopolies are price setters rather than price takers.[2]
Entry and exit
Barriers to entry are high.[3] The most important barriers are government licenses, economies of scale,
patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to
discourage or destroy nascent firms. Additional sources of barriers to entry often result from government
regulation favoring existing firms making it difficult for new firms to enter the market.[4]
Number of firms
"Few" a "handful" of sellers.[3] There are so few firms that the actions of one firm can influence the actions
of the other firms.[5]
Long run profits
Oligopolies can retain long run abnormal profits. High barriers of entry prevent sideline firms from entering
market to capture excess profits.
Product differentiation
Product may be homogeneous (steel) or differentiated (automobiles).[4]
Perfect knowledge
Assumptions about perfect knowledge vary but the knowledge of various economic factors can be generally
described as selective. Oligopolies have perfect knowledge of their own cost and demand functions but their
inter-firm information may be incomplete. Buyers have only imperfect knowledge as to price,[3] cost and
product quality.
Interdependence
The distinctive feature of an oligopoly is interdependence.[6] Oligopolies are typically composed of a few large
firms. Each firm is so large that its actions affect market conditions. Therefore, the competing firms will be
aware of a firm's market actions and will respond appropriately. This means that in contemplating a market
action, a firm must take into consideration the possible reactions of all competing firms and the firm's
countermoves.[7] It is very much like a game of chess or pool in which a player must anticipate a whole
sequence of moves and countermoves in determining how to achieve his or her objectives. For example, an
oligopoly considering a price reduction may wish to estimate the likelihood that competing firms would also
lower their prices and possibly trigger a ruinous price war. Or if the firm is considering a price increase, it
may want to know whether other firms will also increase prices or hold existing prices constant. This high
degree of interdependence and need to be aware of what other firms are doing or might do is to be

contrasted with lack of interdependence in other market structures. In a perfectly competitive (PC) market
there is zero interdependence because no firm is large enough to affect market price. All firms in
a PC market are price takers, as current market selling price can be followed predictably to maximize shortterm profits. In a monopoly, there are no competitors to be concerned about. In a monopolisticallycompetitive market, each firm's effects on market conditions is so negligible as to be safely ignored by
competitors.
Non-Price Competition
Oligopolies tend to compete on terms other than price. Loyalty schemes, advertisement, and product
differentiation are all examples of non-price competition.

Modeling[edit]
There is no single model describing the operation of an oligopolistic market.[7] The variety and complexity of the
models exist because you can have two to 10 firms competing on the basis of price, quantity, technological
innovations, marketing, and reputation. Fortunately, there are a series of simplified models that attempt to describe
market behavior by considering certain circumstances. Some of the better-known models are the dominant firm
model, the CournotNash model, the Bertrand model and the kinked demand model.

CournotNash model[edit]
Main article: Cournot competition
The CournotNash model is the simplest oligopoly model. The model assumes that there are two equally positioned
firms; the firms compete on the basis of quantity rather than price and each firm makes an output decision assuming
that the other firms behavior is fixed.[8] The market demand curve is assumed to be linear and marginal costs are
constant. To find the CournotNash equilibrium one determines how each firm reacts to a change in the output of the
other firm. The path to equilibrium is a series of actions and reactions. The pattern continues until a point is reached
where neither firm desires to change what it is doing, given how it believes the other firm will react to any
change.[9] The equilibrium is the intersection of the two firms reaction functions. The reaction function shows how
one firm reacts to the quantity choice of the other firm.[10] For example, assume that the firm 1s demand function
is P = (M Q2) Q1 where Q2 is the quantity produced by the other firm and Q1 is the amount produced by firm 1,
[11]

and M=60 is the market. Assume that marginal cost is CM=12. Firm 1 wants to know its maximizing quantity and

price. Firm 1 begins the process by following the profit maximization rule of equating marginal revenue to marginal
costs. Firm 1s total revenue function is RT = Q1 P = Q1(M Q2 Q1) = MQ1 Q1 Q2 Q12. The marginal revenue
function is .[note 1]
RM = CM
M Q2 2Q1 = CM
2Q1 = (M CM) Q2
Q1 = (M CM)/2 Q2/2 = 24 0.5 Q2 [1.1]
Q2 = 2(M CM) 2Q1 = 96 2 Q1 [1.2]
Equation 1.1 is the reaction function for firm 1. Equation 1.2 is the reaction function for firm 2.
To determine the CournotNash equilibrium you can solve the equations simultaneously. The
equilibrium quantities can also be determined graphically. The equilibrium solution would be
at the intersection of the two reaction functions. Note that if you graph the functions the axes
represent quantities.[12] The reaction functions are not necessarily symmetric.[13] The firms may

face differing cost functions in which case the reaction functions would not be identical nor
would the equilibrium quantities.

Bertrand model[edit]
Main article: Bertrand competition
The Bertrand model is essentially the CournotNash model except the strategic variable is
price rather than quantity.[14]
The model assumptions are:

There are two firms in the market

They produce a homogeneous product

They produce at a constant marginal cost

Firms choose prices PA and PB simultaneously

Firms outputs are perfect substitutes

Sales are split evenly if PA = PB[15]

The only Nash equilibrium is PA = PB = MC.

Neither firm has any reason to change strategy. If the firm raises prices it will lose all its
customers. If the firm lowers price P < MC then it will be losing money on every unit sold.[16]
The Bertrand equilibrium is the same as the competitive result.[17] Each firm will produce
where P = marginal costs and there will be zero profits.[14] A generalization of the Bertrand
model is the BertrandEdgeworth model that allows for capacity constraints and more
general cost functions.

Kinked demand curve model[edit]

Main article: Kinked demand
According to this model, each firm faces a demand curve kinked at the existing price.[18] The
conjectural assumptions of the model are; if the firm raises its price above the current existing
price, competitors will not follow and the acting firm will lose market share and second if a
firm lowers prices below the existing price then their competitors will follow to retain their
market share and the firm's output will increase only marginally.[19]
If the assumptions hold then:

The firm's marginal revenue curve is discontinuous (or rather, not differentiable), and
has a gap at the kink[18]

For prices above the prevailing price the curve is relatively elastic[20]

For prices below the point the curve is relatively inelastic[20]

The gap in the marginal revenue curve means that marginal costs can fluctuate without
changing equilibrium price and quantity.[18] Thus prices tend to be rigid.

Examples[edit]
In industrialized economies, barriers to entry have resulted in oligopolies forming in many
sectors, with unprecedented levels of competition fueled by increasing globalization. Market
shares in an oligopoly are typically determined by product development and advertising. For
example, there are now only a small number of manufacturers of civil passenger aircraft,
though Brazil (Embraer) and Canada (Bombardier) have participated in the small passenger
aircraft market sector. Oligopolies have also arisen in heavily-regulated markets such as
wireless communications: in some areas only two or three providers are licensed to operate.

Australia[edit]

Most media outlets are owned either by News Corporation, Time Warner, or by Fairfax
Media[21]

Grocery retailing is dominated by Coles Group and Woolworths.[citation needed]

Banking is dominated by ANZ, Westpac, NAB, and Commonwealth Bank. To an extent

this oligopoly is enshrined in law in what is known as the "Four pillars policy", in order to
ensure the stability of Australia's banking system.

Fixed line telecommunications products in Australia are primarily delivered

by Telstra, Optus or increasingly NBN Co. Other brands are virtual network operators
(VNO). In the mobile market there are three main
operators, Telstra, Optus and Vodafone Hutchison Australia. With other mobile virtual
network operators (MVNO) selling access to those three networks.

Canada[edit]

Seven companies (Royal Bank of Canada, Toronto Dominion Bank, Bank of Nova
Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce, Desjardins
Group and National Bank of Canada) control the banking industry.

As of 2008, three companies (Rogers Wireless, Bell Mobility and Telus Mobility) share
over 94% of Canada's wireless market.[22][23]

4 companies control the internet service provider market, (Rogers Communications, Bell
Canada, Telus, Shaw Communications)

7 companies control the oil and gas market, (Husky Energy, Imperial Oil, Nexen, Shell
Canada, Suncor Energy, Syncrude Canada, Talisman Energy)

India[edit]

The petroleum and gas industry is dominated by Indian Oil, Bharat

Petroleum, Hindustan Petroleum, Reliance Petroleum, and Tata Power.

Most of the telecommunication in India is dominated by Airtel, Vodafone India, Idea

Cellular, Reliance Communications, as well as Tata Teleservices and Tata Sky.

European Union[edit]

The VHF Data Link market as air-ground part of aeronautical communications is

controlled by ARINC and SITA, commonly known as the organisations providing
communication services for the exchange of data between air-ground applications in the
Commission Regulation (EC) No 29/2009.

United Kingdom[edit]

Five banks (Barclays, Halifax, HSBC, Lloyds TSB and Natwest) dominate the UK
banking sector, they were accused of being an oligopoly by the relative newcomer Virgin
bank.[24]

Four companies (Tesco, Sainsbury's, Asda and Morrisons) share 74.4% of the grocery
market.[25]

The detergent market is dominated by two players, Unilever and Procter & Gamble.[26]

Six utilities (EDF Energy, Centrica, RWE npower, E.on, Scottish Power and Scottish and
Southern Energy) share 95% of the retail electricity market.[27]

United States[edit]

Many media industries today are essentially oligopolies.

Six movie studios receive almost 87% of American film revenues.[28]

The television and high speed internet industry is mostly an oligopoly of seven
companies: The Walt Disney Company, CBS
Corporation, Viacom, Comcast, Hearst Corporation, Time Warner, and News
Corporation.[29] See Concentration of media ownership.

Four wireless providers (AT&T Mobility, Verizon Wireless, T-Mobile, Sprint Nextel)
control 89% of the cellular telephone service market.[30] This is not to be confused
with cellular telephone manufacturing, an integral portion of the cellular telephone
market as a whole.

Healthcare insurance in the United States consists of very few insurance companies
controlling major market share in most states. For example, California's insured
population of 20 million is the most competitive in the nation and 44% of that market is
dominated by two insurance companies, Anthem and Kaiser Permanente.[31]

In March 2012, the United States Department of Justice announced that it would sue six
major publishers for price fixing in the sale of electronic books. The accused publishers
are Apple, Simon & Schuster Inc, Hachette Book Group, Penguin Group, Macmillan, and
HarperCollins Publishers.[32][33][34]

Mergers among airlines have left the industry in the United States dominated by four
main entities Delta Air Lines, United Airlines, Southwest Airlines and American
Airlines which purposely do not compete on some air travel routes.[35]

Worldwide[edit]

The accountancy market is dominated by PriceWaterhouseCoopers, KPMG, Deloitte

Touche Tohmatsu, and Ernst & Young (commonly known as the Big Four)[36]

Three leading food processing companies, Kraft Foods, PepsiCo and Nestl, together
achieve a large proportion[vague] of global processed food sales. These three companies
are often used as an example of "Rule of three",[37] which states that markets often
become an oligopoly of three large firms.

Boeing and Airbus have a duopoly over the airliner market.[38]

General Electric, Pratt and Whitney and Rolls-Royce plc own more than 50% of the
marketshare in the airliner engine market.[citation needed]

Three credit rating agencies (Standard & Poor's, Moody's, and Fitch Group) dominate
their market and extend their crucial importance into the financial sector. See Big Three
(credit rating agencies).

Nestl, The Hershey Company and Mars, Incorporated together make most of the
confectionery made worldwide.

Intel and AMD are the only two major players in desktop CPU market worldwide.

Microsoft, Sony, Valve, and Nintendo dominate the video game platform market.

Nvidia and AMD together make most of the chips for discrete graphics.

Aircraft tires is dominated by a four firm oligopoly that controls 85% of market share.[39]

Demand curve[edit]

Above the kink, demand is relatively elastic because all other firms' prices remain unchanged. Below the
kink, demand is relatively inelastic because all other firms will introduce a similar price cut, eventually
leading to a price war. Therefore, the best option for the oligopolist is to produce at point Ewhich is the
equilibrium point and the kink point. This is a theoretical model proposed in 1947, which has failed to
receive conclusive evidence for support.

In an oligopoly, firms operate under imperfect competition. With the fierce price
competitiveness created by this sticky-upward demand curve, firms use non-price
competitionin order to accrue greater revenue and market share.
"Kinked" demand curves are similar to traditional demand curves, as they are downwardsloping. They are distinguished by a hypothesized convex bend with a discontinuity at the
bend"kink". Thus the first derivative at that point is undefined and leads to a jump
discontinuity in the marginal revenue curve.
Classical economic theory assumes that a profit-maximizing producer with some market
power (either due to oligopoly or monopolistic competition) will set marginal costs equal to
marginal revenue. This idea can be envisioned graphically by the intersection of an upwardsloping marginal cost curve and a downward-sloping marginal revenue curve (because the
more one sells, the lower the price must be, so the less a producer earns per unit). In
classical theory, any change in the marginal cost structure (how much it costs to make each
additional unit) or the marginal revenue structure (how much people will pay for each
additional unit) will be immediately reflected in a new price and/or quantity sold of the item.
This result does not occur if a "kink" exists. Because of this jump discontinuity in the marginal
revenue curve, marginal costs could change without necessarily changing the price or
quantity.
The motivation behind this kink is the idea that in an oligopolistic or monopolistically
competitive market, firms will not raise their prices because even a small price increase will
lose many customers. This is because competitors will generally ignore price increases, with
the hope of gaining a larger market share as a result of now having comparatively lower
prices. However, even a large price decrease will gain only a few customers because such
an action will begin a price war with other firms. The curve is therefore moreprice-elastic for
price increases and less so for price decreases. Theory predicts that firms will enter the
industry in the long run.

What is an 'Oligopoly'
Oligopoly is a market structure in which a small number of firms has the large majority of market
share. An oligopoly is similar to a monopoly, except that rather than one firm, two or more firms
dominate the market. There is no precise upper limit to the number of firms in an oligopoly, but the
number must be low enough that the actions of one firm significantly impact and influence the others.

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 aprice
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 useproduct
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

Oligopoly
Defining and measuring oligopoly
An oligopoly is a market structure in which a few firms dominate. When a
market is shared between a few firms, it is said to be highly concentrated.
Although only a few firms dominate, it is possible that many small firms may
also operate in the market. For example, major airlines like British
Airways(BA) and Air France operate their routes with only a few close
competitors, but there are also many small airlines catering for the
holidaymaker or offering specialist services.

Concentration ratios
Oligopolies may be identified using concentration ratios, which measure the
proportion of total market share controlled by a given number of firms. When
there is a high concentration ratio in an industry, economists tend to identify
the industry as an oligopoly.

Example of a hypothetical concentration ratio

The following are the annual sales, in m, of the six firms in a hypothetical
market:
A = 56
B = 43
C = 22
D = 12
E=3

F=1
In this hypothetical case, the 3-firm concentration ratio is 88.3%, that is
121/137 x 100.

Examples
Fixed Broadband services
Fixed broadband supply in the UK is dominated by four main suppliers - BT
(with a market share of 32%), Virgin Media (at 20%), Sky (at 22%) and
TalkTalk (at 14%), making a four-firm concentration ratio of
86% (2015). Source: OFCOM.

Fuel retailing
Fuel retailing in the UK is dominated by six major suppliers, including Tesco,
BP, Shell, Esso, Morrisons and Sainsbury, as shown below:
Tesco: 19.26%BP: 19.13%Shell: 15.92%Esso: 13.61%Morrisons: 11.55%Sainsbury: 11.17%Total: 9.37%UK petrol retailing market shares2012;
Source: www.catalyst.comwww.economicsonline.co.uk
Tesco15BP14.9Shell12.4Esso10.6Morrisons9Sainsbury8.7Total7.3

Further examples
Cinema attendances
Banking

The Herfindahl Hirschman Index (H-H Index)

This is an alternative method of measuring concentration and for tracking
changes in the level of concentration following mergers. The H-H index is
found by adding together the squared values of the % market shares of all the
firms in the market. For example, if three firms exist in the market the formula
is X2 + Y2+ Z2; where X, Y and Z are the percentages of the three firms market
shares.
If the index is below 1000, the market is not considered concentrated, while
an index above 2000 indicates a highly concentrated market or industry the
higher the figure the greater the concentration.

Mergers between oligopolists increase concentration and monopoly power

and are likely to be the subject of regulation.

Key characteristics
The main characteristics of firms operating in a market with few close rivals
include:

Interdependence
Firms that are interdependent cannot act independently of each other. A firm
operating in a market with just a few competitors must take the potential
reaction of its closest rivals into account when making its own decisions. For
example, if a petrol retailer like Texaco wishes to increase its market share by
reducing price, it must take into account the possibility that close rivals, such
as Shell and BP, may reduce their price in retaliation. An understanding
of game theory and the Prisoners Dilemma helps appreciate the concept of
interdependence.

Strategy
Strategy is extremely important to firms that are interdependent. Because
firms cannot act independently, they must anticipate the likely response of a
rival to any given change in their price, or their non-price activity. In other
words, they need to plan, and work out a range of possible options based on
how they think rivals might react.
Oligopolists have to make critical strategic decisions, such as:

Whether to compete with rivals, or collude with them.

Whether to raise or lower price, or keep price constant.

Whether to be the first firm to implement a new strategy, or whether to

wait and see what rivals do. The advantages of going first or going second
are respectively called 1st and 2nd-mover advantage. Sometimes it pays to
go first because a firm can generate head-start profits. 2nd mover advantage
occurs when it pays to wait and see what new strategies are launched by
rivals, and then try to improve on them or find ways to undermine them.

Barriers to entry
Oligopolies and monopolies frequently maintain their position of dominance in
a market might because it is too costly or difficult for potential rivals to enter
the market. These hurdles are called barriers to entry and the incumbent can
erect them deliberately, or they can exploit natural barriers that exist.

Natural entry barriers include:

Economies of large scale production.
If a market has significant economies of scale that have already been
exploited by the incumbents, new entrants are deterred.

Ownership or control of a key scarce resource

Owning scarce resources that other firms would like to use creates a
considerable barrier to entry, such as an airline controlling access to an
airport.

High set-up costs

High set-up costs deter initial market entry, because they increase break-even
output, and delay the possibility of making profits. Many of these costs
aresunk costs, which are costs that cannot be recovered when a firm leaves
a market, and include marketing and advertising costs and other fixed costs.

High R&D costs

Spending money on Research and Development (R & D) is often a signal to
potential entrants that the firm has large financial reserves. In order to
compete, new entrants will have to match, or exceed, this level of spending in
order to compete in the future. This deters entry, and is widely found in
oligopolistic markets such as pharmaceuticals and the chemical industry.

Artificial barriers include:

Predatory pricing

Predatory pricing occurs when a firm deliberately tries to push prices low
enough to force rivals out of the market.

Limit pricing
Limit pricing means the incumbent firm sets a low price, and a high output, so
that entrants cannot make a profit at that price. This is best achieved by
selling at a price just below the average total costs (ATC) of potential
entrants. This signals to potential entrants that profits are impossible to make.

Superior knowledge
An incumbent may, over time, have built up a superior level of knowledge of
the market, its customers, and its production costs. This superior knowledge
can deter entrants into the market.

Predatory acquisition
Predatory acquisition involves taking-over a potential rival by purchasing
sufficient shares to gain a controlling interest, or by a complete buy-out. As
with other deliberate barriers, regulators, like the Competition and Markets
Authority (CMA), may prevent this because it is likely to reduce competition.

Advertising
Advertising is another sunk cost - the more that is spent by incumbent firms
the greater the deterrent to new entrants.

A strong brand
A strong brand creates loyalty, locks in existing customers, and deters entry.

Loyalty schemes
Schemes such as Tescos Club Card, help oligopolists retain customer loyalty
and deter entrants who need to gain market share.

Exclusive contracts, patents and licences

These make entry difficult as they favour existing firms who have won the
contracts or own the licenses. For example, contracts between suppliers and
retailers can exclude other retailers from entering the market.

Vertical integration
Vertical integration can tie up the supply chain and make life tough for
potential entrants, such as an electronics manufacturer like Sony having its
own retail outlets (Sony Centres), and a brewer like Heineken owning its own
chain of UK pubs, which it acquired from the brewers Scottish and Newcastle
in 2008.

Collusive oligopolies
Another key feature of oligopolistic markets is that firms may attempt to
collude, rather than compete. If colluding, participants act like
a monopoly and can enjoy the benefits of higher profits over the long term.

Types of collusion
Overt
Overt collusion occurs when there is no attempt to hide agreements, such as
the when firms form trade associations like the Association of Petrol Retailers.

Covert
Covert collusion occurs when firms try to hide the results of their collusion,
usually to avoid detection by regulators, such as when fixing prices.

Tacit
Tacit collusion arises when firms act together, called acting in concert, but
where there is no formal or even informal agreement. For example, it may be
accepted that a particular firm is the price leader in an industry, and other
firms simply follow the lead of this firm. All firms may understand this, but no
agreement or record exists to prove it. If firms do collude, and their behaviour
can be proven to result in reduced competition, they are likely to be subject to
regulation. In many cases, tacit collusion is difficult or impossible to prove,
though regulators are becoming increasingly sophisticated in developing new
methods of detection.

Competitive oligopolies
When competing, oligopolists prefer non-price competition in order to avoid
price wars. A price reduction may achieve strategic benefits, such as gaining
market share, or deterring entry, but the danger is that rivals will simply reduce
their prices in response.
This leads to little or no gain, but can lead to falling revenues and profits.
Hence, a far more beneficial strategy may be to undertake non-price
competition.

Pricing strategies of oligopolies

Oligopolies may pursue the following pricing strategies:
1. Oligopolists may use predatory pricing to force rivals out of the market.
This means keeping price artificially low, and often below the full cost of
production.
2. They may also operate a limit-pricing strategy to deter entrants, which is
also called entry forestalling price.
3. Oligopolists may collude with rivals and raise price together, but this
may attract new entrants.
4. Cost-plus pricing is a straightforward pricing method, where a firm sets
a price by calculating average production costs and then adding a
fixedmark-up to achieve a desired profit level. Cost-plus pricing is also
calledrule of thumb pricing.
There are different versions of cost-pus pricing, including full cost
pricing, where all costs - that is, fixed and variable costs - are
calculated, plus a mark up for profits, and contribution pricing, where
only variable costs are calculated with precision and the mark-up is a
contribution to both fixed costs and profits.

Cost-plus pricing is very useful for firms that produce a number of

different products, or where uncertainty exists. It has been suggested
that cost-plus pricing is common because a precise calculation of
marginal cost and marginal revenue is difficult for many oligopolists.
Hence, it can be regarded as a response to information failure. Costplus pricing is also common in oligopoly markets because it is likely that
the few firms that dominate may often share similar costs, as in the case
of petrol retailers.
However, there is a risk with such a rigid pricing strategy as rivals could
adopt a more flexible discounting strategy to gain market share.
Cost-plus pricing can also be explained through the application of game
theory. If one firm uses cost-plus pricing - perhaps the dominant firm
with the greatest market share - others may follow-suit so that the
strategy becomes a shared one, which acts as a pricing rule. This takes
some of the risk out of pricing decisions, given that all firms will abide by
the rule. This could be considered a form of tacit collusion.

Non-price strategies
Non-price competition is the favoured strategy for oligopolists because price
competition can lead to destructive price wars examples include:

1. Trying to improve quality and after sales servicing, such as offering

extended guarantees.
2. Spending on advertising, sponsorship and product placement - also
called hidden advertising is very significant to many oligopolists. The
UK's football Premiership has long been sponsored by firms in
oligopolies, including Barclays Bank and Carling.
3. Sales promotion, such as buy-one-get-one-free (BOGOF), is associated
with the large supermarkets, which is a highly oligopolistic market,
dominated by three or four large chains.
4. Loyalty schemes, which are common in the supermarket sector, such
asSainsburys Nectar Card and Tescos Club Card.
Each strategy can be evaluated in terms of:
1. How successful is it likely to be?
2. Will rivals be able to copy the strategy?
3. Will the firms get a 1st - mover advantage?
4. How expensive is it to introduce the strategy? If the cost of
implementation is greater than the pay-off, clearly it will be rejected.
5. How long will it take to work? A strategy that takes five years to
generate a pay-off may be rejected in favour of a strategy with a quicker
pay-off.

Price stickiness
The theory of oligopoly suggests that, once a price has been determined,
willstick it at this price. This is largely because firms cannot pursue
independent strategies. For example, if an airline raises the price of its tickets
from London to New York, rivals will not follow suit and the airline will lose
revenue - the demand curve for the price increase is relatively elastic. Rivals
have no need to follow suit because it is to their competitive advantage to
keep their prices as they are.

However, if the airline lowers its price, rivals would be forced to follow suit and
drop their prices in response. Again, the airline will lose sales revenue and
market share. The demand curve is relatively inelastic in this context.

Kinked demand curve

The reaction of rivals to a price change depends on whether price is raised or
lowered. The elasticity of demand, and hence the gradient of the demand
curve, will be also be different. The demand curve will be kinked, at
the currentprice.

Even when there is a large rise in marginal cost, price tends to stick close to
its original, given the high price elasticity of demand for any price rise.

At price P, and output Q, revenue will be maximised.

Maximising profits
If marginal revenue and marginal costs are added it is possible to show that
profits will also be maximised at price P. Profits will always be maximised
when MC = MR, and so long as MC cuts MR in its vertical portion, then profit
maximisation is still at P. Furthermore, if MC changes in the vertical portion of
the MR curve, price still sticks at P. Even when MC moves out of the vertical
portion, the effect on price is minimal, and consumers will not gain the benefit
of any cost reduction.

A game theory approach to price stickiness

Pricing strategies can also be looked at in terms of game theory; that is in
terms of strategies and payoffs. There are three possible price strategies, with
different pay-offs and risks:

Raise price

Lower price

Keep price constant

The choice of strategy will depend upon the pay-offs, which depends upon the
actions of competitors. Raising price or lowering price could lead to a
beneficial pay-off, but both strategies can lead to losses, which could be
potentially disastrous. In short, changing price is too risky to undertake.
Therefore, although keeping price constant will not lead to the single best
outcome, it may be the least risky strategy for an oligopolist.

Video

The Prisoners Dilemma

Game theory also predicts that:
There is a tendency for cartels to form because co-operation is likely to be
highly rewarding. Co-operation reduces the uncertainty associated with
themutual interdependence of rivals in an oligopolistic market. While cartels
are unlawful in most countries, they may still operate, with members
concealing their unlawful behaviour.
Cartels are designed to protect the interests of members, and the interests of
consumers may suffer because of:
1. Higher prices or hidden prices, such as the hidden charges in credit
card transactions
2. Lower output
3. Restricted choice or other limiting conditions associated with the
transaction
A classic game called the Prisoner's Dilemma is often used to demonstrate
the interdependence of oligopolists.

Examples of Oligopoly
Oligopolies are common in the airline industry, banking, brewing, softdrinks,supermarkets and music. For example, the manufacture, distribution
and publication of music products in the UK, as in the EU and USA, is highly
concentrated, with a 4-firm concentration ratio of around 75%, and is usually
identified as an oligopoly.

The key players in 2011 were:

Evaluation of oligopolies
Oligopolies are significant because they generate a considerable share of the
UKs national income, and they dominate many sectors of the UK economy.

The disadvantages of oligopolies

Oligopolies can be criticised on a number of obvious grounds, including:
1. High concentration reduces consumer choice.
2. Cartel-like behaviour reduces competition and can lead to higher prices
and reduced output.
3. Given the lack of competition, oligopolists may be free to engage in the
manipulation of consumer decision making. By making decisions more
complex - such as financial decisions about mortgages - individual
consumers fall back on heuristics and rule of thumb processes, which
can lead to decision making bias and irrational behaviour, including
making purchases which add no utility or even harm the individual
consumer.
4. Firms can be prevented from entering a market because of
deliberatebarriers to entry.
5. There is a potential loss of economic welfare.
6. Oligopolists may be allocatively and productively inefficient.
Oligopolies tend to be both allocatively and productively inefficient. At profit
maximising equilibrium, P, prce is above MC, and output, Q, is less than the
productively efficient output, Q1, at point A.

The advantages of oligopolies

However, oligopolies may provide the following benefits:
1. Oligopolies may adopt a highly competitive strategy, in which case they
can generate similar benefits to more competitive market structures,
such as lower prices. Even though there are a few firms, making the
market uncompetitive, their behaviour may be highly competitive.
2. Oligopolists may be dynamically efficient in terms of innovation and new
product and process development. The super-normal profits they
generate may be used to innovate, in which case the consumer may
gain.
3. Price stability may bring advantages to consumers and the macroeconomy because it helps consumers plan ahead and stabilises their
expenditure, which may help stabilise the trade cycle.