Oligopolistic Rivalry

Oligopolistic Rivalry

Oligopoly, remember, is a market structure where there are a few,
very large corporations sharing power in an industry with substantial
barriers to entry restricting access to any other firms. In such a
situation, each business would ideally want to dominate the market
and so rivalry is intense: every firm has to keep a close eye on the
actions of its competitors.
Imagine the scenario with five firms dominating an industry –
each with 20 per cent market share. If one supplier wishes, say, to
cut the price of its product and thus compete more business away
from its rivals then you can be sure that the other four firms will be
equally determined not to let this happen. In an example of pricecutting,
all would promptly follow suit. The end result would thus
be all five businesses would retain the same market share but now
at a lower, less profitable price.
Driving prices down to the limit where average revenues equal
average costs and only normal profits remain is the inevitable
outcome of competitive industry where new entrants cannot be
excluded. But where barriers to competition limit production to a few,
very large businesses, each one warily watching the other, it is
extremely unlikely that the rivals would want to engage in price wars.
More likely they would want to collude and push prices up to all
firms’ mutual advantage. The oligopolists thus act as one – joint profit
maximisation – which is the typical outcome of a CARTEL (Box 3.3).
Rigging prices is against the law, however. Active collusion must
be avoided since it can be severely punished – though this still does
not remove the incentive, under oligopoly, for competition to be
constrained. What results, therefore, is tacit collusion: a passive,
unspoken (and thus unpunishable) understanding not to excessively
stir up deep waters.
There is an inevitable reluctance to engage in extremely rivalrous
and damaging ‘cut-throat’ price wars and instead a preference
to move competition into the realms of advertising, marketing,
‘special offers’ and other sales promotions. Investing in large
marketing divisions and resorting to creative ways to practice NONPRICE
COMPETITION can also be costly but it is a safer, less
unpredictable business practice and mutually beneficial to the
existing rivals in that it builds up even higher barriers to potential
new competition.
© 2004 Tony Cleaver
Oligopoly Demand
The demand curve for the firm – which shows the relationships
between the price of the product and its quantity sold – given the
oligopoly conditions just described can be quite unique. Consider
what would happen if one of the rival corporations was determined
Box 3.3 Cartels
It is precisely the tendency to COLLUSION that governments need
to monitor and legislate against in order to prevent the public
from being exploited. Setting up a cartel – a formal agreement
between rivals to rig the market – is illegal in most countries,
though cartels between international operators are more difficult
to outlaw since there is no one world body that can be relied
upon to stop them (especially if it is national governments that
actively collude!)
The Organisation of Petroleum Exporting Countries (OPEC) is
frequently cited as a cartel but in fact it has been far less
exploitative than the cartel of major oil companies that preceded
it and formerly controlled international oil supplies (see Box 6.9).
The national governments represented by OPEC now regularly
meet to arrange production quotas between them but disagreement
is common.
What conditions are likely to be conducive to the successful
operation of a cartel? Under what circumstances must governments
be most vigilant to protect the interests of consumers?
Collusion is most likely to succeed:
1 the smaller the number of rival producers and the higher the
barriers to entry;
2 where the interests and objectives of each producer are
similar;
3 where the product is homogenous, difficult to differentiate
and thus highly substitutable;
4 where the actions of each producer are highly visible to all;
5 where market demand is stable;
6 where legal restrictions can be easily bypassed or bought off.
© 2004 Tony Cleaver
to change its selling price: as Firm A cuts its price, so too would
Firms B, C, D and E. The sales of all products in the market place
may grow a little overall but the individual demand for each firm
would not change by much. If, in contrast, Firm A puts its price up
then it is unlikely that any of its rivals would follow suit. Firms B,
C, D and E would benefit from extra sales if they kept their prices
low, picking up consumers of product A who would now switch to
the rivals’ lower price alternatives (Box 3.4).
Box 3.4 Price stickiness
With asymmetric demand in the market for the products of
oligopoly, the shape of each firm’s AR/demand curve would be
kinked at the point of the current ruling price, P as illustrated in
Figure 3.6.
Demand for the oligopolist’s product is price-elastic above
price P and price-inelastic below P . Note the MR curve that is
derived from a kinked AR/demand curve is shown as vertical at
quantity Q . What this implies is that – since the oligopolist
maximises profit at that output where MC equal MR – no matter
if production costs increase quite considerably (e.g. anywhere
Price/revenue
P
C
Demand/AR
MR
0 Q
Output
Figure 3.6 The oligopolist’s demand curve.
© 2004 Tony Cleaver
Prices under oligopoly tend to be stable, therefore. At least they will
be so for relatively long periods until something occurs to upset the
equilibrium. The sudden appearance of a new competitor, a technological
breakthrough or a revolutionary new product or process
may then turn the relative stability of the status quo into turmoil.
For a brief period, an intense battle over market shares will take
place as the original ‘pecking order’ or hierarchy between rivals is
challenged. Cut-throat price competition may be resorted to in
order to eject an upstart interloper from the market place or to reexamine
the economic efficiency and thus supremacy of the
remaining firms. After a period of aggressive activity where shortterm
profits are sacrificed in the quest for a new order, eventual
from 0 to C ) price and output will still not change. This is
shown in Figure 3.7.
Adding the oligopolist’s cost structure to the pattern of
demand identifies the firm’s equilibrium price P* and output Q*.
Abnormal profits are given by the box (P* C*)Q*. Note that
the effect on this equilibrium of any increase or decrease of MC
and AC here would be minimal, whereas a shift back in demand
(AR) caused by any increase in competition from rivals would
have, in contrast, a serious impact on price, output and profits.
Price/costs/revenue
MC
P*
AC
C*
AR
MR
0 Q*
Output
Figure 3.7 Profit-maximising oligopoly.
© 2004 Tony Cleaver
calm will be restored as all survivors realise that mutual interests
are best served again by tacit collusion.
A highly dramatised and fictional (?) illustration of oligopolistic
conflict is given in the novel The Godfather by Mario Puzo – a
fascinating study of rivalry between New York Mafia organisations
which gives new meaning to cut-throat, corporate blood-letting!
Only slightly less colourful have been reports on the antics of
international airlines in trying to carve up North Atlantic passenger
routes. The end of the twentieth century saw the major players in
this market accused of all sorts of dirty tricks designed to prevent
the entry of new budget airline operators such as Laker Airways
(successfully beaten off in the 1960s) and, later, Virgin Airways
(forewarned, forearmed and able to establish itself in the more
competitive 1990s).
Many examples of oligopolistic rivalry can be quoted where, in
between the extremes of intense competition or secretive collusion,
the pre-occupation of business leaders in protecting market share
and pursuing profits seems to be at the direct expense of the
public’s interest. Big tobacco companies have deliberately
suppressed information of the harmful effects of their products;
international banks have promoted cheap loans and increased the
indebtedness of poorer peoples before hoisting up interest rates;
pharmaceutical giants charge exploitative prices for AIDS vaccines
and other life-saving medicines that consumers must purchase, or
perish (Box 3.5).
Large, oligopolistic corporations that have built up business
empires that span the globe wield an enormous amount of
economic power, therefore. The challenge to governments is how to
channel this corporate muscle so that the ends it pursues suit the
public, as well as business, interests.
Adam Smith famously commented in 1776 that the individual in
a market economy ‘is led by an invisible hand to promote an end
which was no part of his intention. By pursuing his own interest he
frequently promotes that of society more effectually than when he
really intends to promote it’. That sentiment still exerts a persuasive
influence on Western economic policy making: the claim that
all will be for the best if only private enterprise is left alone.
Oligopoly theory predicts otherwise.
© 2004 Tony Cleaver
Box 3.5 Big pharma
At the time of going to press, the world’s largest pharmaceutical
company, Pfizer, reported corporate profits of US$4.7 billion for
one quarter of 2002. It competes with a handful of other US and
European firms world-wide to develop and distribute branded
drugs to combat a variety of medical ailments.
Drug companies such as these do not nowadays act so much
as primary innovators in the field – their home-grown supply of
new products is less important than contracting new ideas from
a host of small, specialist biotech firms. That is, ‘big pharma’
increasingly uses its economies of scale to raise finance, buy out
competition, negotiate/bribe supportive regulations from
governments and international agencies, run lab and field tests
on the latest drugs and to launch massive sales promotions
around the globe. In 2001, the top ten US drug companies spent
$19.1 billion on research and development and more than twice
that, $45.4 billion, on marketing, advertising and administration.
(Quoted in The Times, 20 March 2003.)
Profit-seeking has implications for which markets to serve
and what prices to charge. The biggest killer of children in the
world today is malaria – the prime cause of infant mortality in
the developing world. But poor children and their families have
little purchasing power and no drug company is therefore much
interested in researching better treatment. In contrast, the
biggest killer in the rich world where populations are rapidly
ageing is heart disease. Cholesterol-reducing drugs are a huge
money-spinner, investments are massive and there is much
product differentiation as each oligopolist tries to sell its own
product. (Equally profitable is developing lots of ‘me too’ drug
copies of viagra – to address a less than fatal affliction of older,
richer men.) To maximise profits, prices are highest in those
markets where people are richer, where government regulations
prohibit cheap copies and where the medical consequences of
not buying the drugs are serious . . .
© 2004 Tony Cleaver