What is an Oligopoly Essay Example | Topics and Well Written Essays - 1500 words

What is an Oligopoly - Essay Example Oligopoly, (which is Greek for many sellers) demonstrates a very characteristic feature of mutual interdependence 3of each in the model onto other firm's action. Each firm in an oligopoly recognizes that the pricing or output decisions made by one firm will affect the profits of all firms in the industry.4 Because of this mutual interdependence, the firms in an oligopoly market need to act strategically, and it is this existence of strategic behavior or barriers which distinguish the oligopoly model from perfect competition and monopoly.5 The fundamental features are that sellers are price-makers and the demand curve of every firm is slightly slopping down. As the figure below aptly demonstrates, the demand curve in an oligopoly will be a "Kinked" demand curve which may be similar to the traditional demand curves in the Perfect competition, as they are downward-sloping but it will have a kink or a bend. 6 Before I discuss the barriers utilized by a monopoly it would be useful to show how the factor of interdependence manifests itself as a game theory which can be well illustrated as the prisoner's dilemma as apparent from the diagram below. The above diagram (taken from the internet) shows the classic example of the Game theory being played out between two firms in an oligopoly. These two firms are aware of their price levels and cautious in an increase or decrease in the prices which can break out into a price war/or cause cut-throat pricing which will ultimately cause losses to all the firms in the oligopoly. Economic theory dictates that these firms will inevitably return to the original position in case of such a price war. Barriers in Oligopolies The Game theory as apparent from the diagram above shows some interesting incites into strategic barriers and their dilemmas and this theory became popular in the decade of the 1970s where there was a substantial shift to firm behavior with regards to firm behavior. Barriers in a monopoly can be natural or strategic. They are aimed at keeping competing firms away 7. Market entry is very difficult in oligopolies. Oligopolies operate on a large scale and therefore have high sunk costs( which are industrial expenses that cannot be recovered once a firm has started a business). This means that if large amounts of capital are used to enter an industry which depreciates in value rather quickly there will be a barrier to entry for new aspiring firms. Secondly, if the firm has problems in establishing the reputation of its product through high scale advertising and discount schemes it will be too expensive for other firms to enter the market and actually attain the same level of excellence without incurring large amounts of initial losses. An example of this is the telecoms industry where the various cell phone carriers have established oligopolies in their price and service mechanisms.