Types of market structures: perfect competition, monopolistic competition, oligopoly and monopoly. What are the characteristic features of the functioning of oligopolies
The term oligopoly comes from the Greek words oligos (several) and poleo (sell).
Fundamental due to the small number of firms on the market are their special relationship, manifested in close interdependence and sharp rivalry between. In contrast to or pure monopoly, in an oligopoly, the activity of any of the firms causes a mandatory response from competitors. This interdependence of the actions and behavior of a few firms is key characteristic of an oligopoly and applies to all areas of competition: price, sales volume, market share, investment and innovative activity, sales promotion strategy, after-sales services, etc.
We have already mentioned coefficient of volume, or quantitative, cross elasticity of demand, which serves to quantify the interdependence of firms in the market. This coefficient shows the degree of quantitative change in the price of firm X with a change in the firm's output Y on the 1% .
If the volume cross elasticity of demand is equal to or close to zero (as is the case under perfect competition and pure monopoly), then an individual producer can ignore the reaction of competitors to his actions. Conversely, the higher the elasticity coefficient, the closer the interdependence between firms in the market. Under oligopoly Eq>0, however, its exact value depends on the specifics of the industry in question and specific market conditions.
Homogeneity or differentiation of the product
The type of product produced by an oligopoly can be either homogeneous or diversified.
- If consumers have no special preference for any brand, if all products of the industry are perfect substitutes, then the industry is called a pure or homogeneous oligopoly. The most typical examples of practically homogeneous products are cement, steel, aluminium, copper, lead, newsprint, and viscose.
- If the goods are branded and are not perfect substitutes (and the difference between the goods may be as real (according to technical specifications, design, workmanship, services provided), and imaginary (brand name, packaging, advertising), then the products are considered differentiated, and the industry is called a differentiated oligopoly. Examples are the markets for cars, computers, televisions, cigarettes, toothpaste, soft drinks, beer.
Degree of influence on market prices
The extent of the firm's influence on market prices, or its monopoly power, is high, although not to the same extent as in a pure monopoly.
Bargaining power is determined the relative excess of a firm's market price over its marginal cost(under perfect competition P=MS), or
L=(P-MC)/P.
The quantitative value of this coefficient (Lerner coefficient) for the oligopolistic market is greater than for perfect and monopolistic competition, but less than for pure monopoly, i.e. fluctuates within 0
barriers
Market entry for new firms is difficult but possible.
When considering this characteristic, it is necessary to distinguish between the already established, slow growing markets and young, dynamically developing markets.
- For slow growing oligopolistic markets characteristic very high barriers. As a rule, these are industries with complex technology, large equipment, high minimum efficient production, and significant sales promotion costs. These industries are characterized by positive , due to which the minimum (min ATC) is achieved only with a very large output. In addition, entering a market dominated by well-known brands inevitably leads to high initial investment. Only large competitive firms with the necessary financial and organizational resources can afford to enter such markets.
- For young emerging oligopolistic markets it is possible for new firms to enter because demand expands quickly enough that an increase in supply does not have a downward effect on prices.
Introduction………………………………………………………………………………………….3
1. The concept and signs of oligopoly………………………………………………………………..4
2. Types of oligopoly……………………………………………………………………………………6
3. Models of oligopoly……………………………………………………………………………………………7
Conclusion……………………………………………………………………………………...10
Introduction
Currently, one of the most common market structures are monopolies and oligopolies. However, monopolies remained in their pure form only in a few sectors of the economy. The most predominant form of modern market structure is oligopoly.
The term "oligopoly" is used in economics to describe a market in which there are several firms, each of which controls a significant share of the market.
In an oligopolistic market, several of the largest firms compete with each other and entry into this market of new firms is difficult. Products manufactured by firms can be both homogeneous and differentiated. Homogeneity prevails in the markets for raw materials and semi-finished products; differentiation - in consumer goods markets.
The existence of an oligopoly is associated with restrictions on entry into this market. One of them is the need for significant capital investments to create an enterprise in connection with the large-scale production of oligopolistic firms.
The small number of firms in the oligopolistic market forces these firms to use not only price, but also non-price competition, because the latter is more efficient under such conditions. Manufacturers know that if they lower the price, their competitors will do the same, which will lead to a drop in revenue. Therefore, instead of price competition, which is more effective in today's competitive environment, "oligopolists" use non-price methods of struggle: technical superiority, product quality and reliability, marketing methods, the nature of the services and guarantees provided, differentiation of payment terms, advertising, economic espionage.
For the disclosure of this topic, it is necessary to solve a number of problems:
1. Define the concept and signs of an oligopoly.
2. Consider the main types and models of oligopoly.
The concept and signs of oligopoly
Oligopoly is a type of imperfectly competitive market structure dominated by a very small number of firms. The word "oligopoly" was introduced by the English humanist and statesman Thomas More (1478-1535) in the world-famous novel "Utopia" (1516).
At the heart of the historical trend in the formation of oligopolies is the mechanism of market competition, which with inevitable force forces out weak enterprises from the market either by their bankruptcy or by absorption and merger with stronger competitors. Bankruptcy can be caused both by weak entrepreneurial activity of the enterprise's management, and by the impact of the efforts made by competitors against a particular enterprise. Absorption is carried out on the basis of financial transactions aimed at the acquisition of an enterprise, either in full or in part by buying a controlling stake or a significant share of the capital. This is the relationship between strong and weak competitors.
In the oligopolistic market, several large firms (2 - 10) compete with each other, and entry into this market of new firms is difficult. The products produced by firms can be both homogeneous and differentiated. Homogeneity prevails in the markets of raw materials and semi-finished products: ores, oil, steel, cement; differentiation - in consumer goods markets.
The existence of an oligopoly is associated with restrictions on entry into this market. One of them is the need for significant capital investments to create an enterprise in connection with the large-scale production of oligopolistic firms.
Examples of oligopolies include manufacturers of passenger aircraft, such as Boeing or Airbus, car manufacturers, such as Mercedes, BMW.
The small number of firms in the oligopolistic market forces these firms to use not only price, but also non-price competition, since the latter is more efficient under such conditions. Manufacturers know that if they lower the price, their competitors will do the same, which will lead to a drop in revenue. Therefore, instead of price competition, which is more effective in today's competitive environment, "oligopolists" use non-price methods of struggle: technical superiority, product quality and reliability, marketing methods, the nature of the services and guarantees provided, differentiation of payment terms, advertising, economic espionage.
From the foregoing, the main features of an oligopoly can be distinguished:
1. A small number of firms and a large number of buyers. This means that the market supply is in the hands of a few large firms that sell the product to many small buyers.
2. Differentiated or standardized products. In theory, it is more convenient to consider a homogeneous oligopoly, but if the industry produces differentiated products and there are many substitutes, then this set of substitutes can be analyzed as a homogeneous aggregated product.
3. The presence of significant barriers to entry into the market, i.e. high barriers to entry into the market.
4. Firms in the industry are aware of their interdependence, so price controls are limited.
Types of oligopoly
There are two types of oligopoly:
1. Homogeneous (non-differentiated) - when several companies producing homogeneous (non-differentiated) products operate on the market.
Homogeneous products - products that do not differ in the variety of types, types, sizes, brands (alcohol - 3 grades, sugar - about 8 types, aluminum - about 9 grades).
2. Heterogeneous (differentiated) - several companies create non-homogeneous (differentiated) products. Heterogeneous products - products that are characterized by a wide variety of types, types, sizes, brands.
3. Oligopoly of dominance - a large company operates in the market, specific gravity which in the total volume of production is 60% or more, and therefore it dominates the market. Several small companies operate next to it, which divide the remaining market among themselves.
4. Duopoly - when only 2 manufacturers or traders of this product work on the market.
Characteristic features of the functioning of oligopolies:
1. Both differentiated and non-differentiated products are produced.
2. Decisions of oligopolists regarding production volumes and prices are interdependent, i.e. oligopolies imitate each other in everything. So if one oligopolist lowers prices, then others will definitely follow suit. But if one oligopolist raises prices, then others may not follow his example, because. risk losing their market share.
3. In an oligopoly, there are very tough barriers to other competitors entering this industry, but these barriers can be overcome.
Oligopoly Models
There is no general model for the behavior of an oligopolist when choosing the optimal volume of production that maximizes profit. Since the choice depends on the behavior of the firm in response to changes in the actions of competitors, various situations may arise. In this regard, the following main models of oligopoly are distinguished:
1. Cournot model.
2. Oligopoly based on collusion.
3. Silent collusion: leadership in prices.
Cournot model (duopolies).
This model was introduced in 1838 by the French economist A. Cournot. A duopoly is a situation where only two firms compete with each other in the market. This model assumes that firms produce homogeneous goods and that the market demand curve is known. The profit-maximizing output of firm 1 (£^1) changes depending on how, in her opinion, the output of firm 2 (€?2) will grow. As a result, each firm builds its own reaction curve (Fig. 1).
Rice. 1 Cournot equilibrium
Each firm's response curve tells how much it will produce given its competitor's expected output. In equilibrium, each firm sets its output according to its own reaction curve. Therefore, the equilibrium level of output is at the intersection of the two response curves. This equilibrium is called the Cournot equilibrium. Under it, each duopolist sets the output that maximizes his profit, given the output of his competitor. The Cournot equilibrium is an example of what in game theory is called the Nash equilibrium (when each player does the best he can, given the actions of his opponents, in the end - no player has an incentive to change his behavior) (game theory was described by John Neumann and Oskar Morgenstern in Game Theory and Economic Behavior in 1944).
Collusion.
A conspiracy is an actual agreement between firms in an industry to fix prices and production volumes. Such an agreement is called a cartel. The international cartel OPEC, which unites oil exporting countries, is widely known. In many countries collusion is considered illegal, and in Japan, for example, it has become widespread. Conspiracy factors include:
· Availability legal framework;
· high concentration of sellers;
Approximately the same average costs for firms in the industry;
Impossibility of entry of new firms into the market.
It is assumed that under collusion, each firm will equalize its prices both when prices go down and when prices go up. At the same time, firms produce homogeneous products and have the same average cost. Then, when choosing the optimal volume of production that maximizes profit, the oligopolist behaves like a pure monopolist. If two firms agree, then they build a contract curve (Fig. 2):
Rice. 2 Collusion contract curve
It shows the different combinations of outputs of the two firms that maximize profits.
Collusion is much more profitable for firms than not only perfect equilibrium, but also Cournot equilibrium, since they will produce less output and set the price higher.
Silent conversation.
There is another model of oligopolistic behavior based on a tacit secret agreement: this is "price leadership", when the dominant firm in the market changes the price, and all others follow this change. The price leader, with the tacit consent of the rest, is assigned the leading role in setting industry prices. The price leader can announce a price change, and if his calculation is correct, then the rest of the firms also increase prices. As a result, the industry price changes without collusion. For example, General Motors in the USA installs on its new model a certain price, and Ford and Chrysler charge about the same price for their new cars in the same class. If other firms do not support the leader, then he refuses to increase the price, and with the frequent repetition of such a situation, the leader in the market changes.
Conclusion
Assessing the importance of oligopolistic structures, it is important to note the following:
1. The inevitability of their formation as an objective process that follows from open competition and the desire of enterprises to achieve optimal production scales.
2. Despite both the positive and negative assessment of oligopolies in modern economic life, one should recognize the objective inevitability of their existence.
A positive assessment of oligopolistic structures is associated, first of all, with the achievements of scientific and technological progress. Indeed, in recent decades, in many industries with oligopolistic structures, significant progress has been made in the development of science and technology (space, aviation, electronics, chemical, oil industries). The oligopoly has huge financial resources, as well as significant influence in the political and economic circles of society, which allows them, with varying degrees of accessibility, to participate in the implementation of profitable projects and programs, often financed from public funds. Small competitive enterprises, as a rule, do not have sufficient funds to implement existing developments.
The negative assessment of oligopolies is determined by the following points. This is, first of all, that an oligopoly is very close in its structure to a monopoly, and, therefore, one can expect the same negative consequences as with the market power of a monopolist. Oligopolies, by concluding secret agreements, get out of state control and create the appearance of competition, while in fact they seek to benefit at the expense of buyers. Ultimately, this leads to a decrease in the efficiency of the use of available resources and a deterioration in meeting the needs of society.
Despite significant financial resources, concentrated in oligopolistic structures, most of the new products and technologies are developed by independent inventors, as well as small and medium enterprises engaged in research activities. However, only large enterprises that are part of oligopolistic structures often have the technological capabilities for the practical implementation of the achievements of science and technology. In this regard, oligopolies use the opportunity to achieve success in technology, production and the market based on the developments of small and medium-sized businesses that do not have sufficient capital for their technological implementation.
Based on this, we can conclude that the oligopoly, although it does not satisfy the abstract conditions for the efficient use and distribution of resources, in reality it is effective, as it makes an important contribution to economic growth, actively participating in the research and development of new products and technologies, and also introducing these inventions into production.
Competition dominated by only one or a few firms. Today, a good example is the passenger airliner market. It is almost impossible to compete with Airbus and Boeing. A similar situation has developed in the car market.
Basic concepts
Oligopoly is a state of the market where a small number of companies or brands compete for dominance. Undoubtedly, the leaders of the race are large firms, which have both higher authority and a well-developed PR campaign. The goods and services provided by the oligopoly market are similar to those of competitors. A striking example is mobile phones, washing powders, etc.
It is noteworthy that so-called price competition is practically not used in modern markets. Today, firms, on the contrary, are trying to become leaders in sales through alternative types of oligopoly. That is why it is extremely difficult for new participants to enter such a market. To enter the race for leadership, you must follow legal restrictions and have a huge initial capital for business development.
To enter an oligopoly, it is important to comply with a number of conditions. One of them is information content and openness. Any company is afraid of rash actions of competitors that can reduce its profits. Therefore, the subjects of the "alliance" are obliged to inform each other about possible changes and novelties. This consistency strengthens competitors, preventing other firms from taking leading positions. Such a vision of the situation is called strategic. At the same time, any changes in the activities of a competitor cannot be short-term.
On the this moment There are 2 types of oligopolies. The first is called cooperative. Consistency is the main point in it. The second group is non-cooperative. According to this strategy, competitors are fighting for market leadership in all possible ways. In addition, there are many oligopoly models. However, in reality, only a few of them are used.
Features of the cartel model
This is a kind of oligopoly based on collusion. Each market representative has the right to choose individual or cooperative behavior. Both strategies can be winning in the right hands. The advantages of the first kind of behavior are the possibility of concluding secret alliances, raising prices, etc.
Cooperative strategy allows you to collude with the most powerful competitors. As a result, companies jointly set prices, produce the same volumes of products, evenly divide the market, and jointly fight against various sanctions.
In this case, oligopoly is a powerful weapon in the fight against the crisis. Firms are not obliged to help each other, but all aspects related to products and services are strictly negotiated. Such oligopoly models are based on the strategy of a cartel (a group of companies that act in concert). This includes levers for managing prices, volumes, and product quality.
Price war model
In another way, the strategy is called Bertrand competition. This model was formulated by a French economist at the end of the 19th century. Here, oligopoly is competition based on the cost of products and services.
The model describes the price change strategy. The main law of Bertrand's theory is the appointment of the cost of goods, equal to the maximum cost in conditions of marginal competition.
For the model to be effective, the following sentences and conditions are required:
1. The market must consist of at least two large homogeneous companies.
2. Firms may behave inconsistently.
3. Under normal price competition, the demand function must be linear.
4. With the same cost of production, the profit of companies is comparable.
5. With a decrease in prices, the demand for goods and services rises markedly.
6. Regulation of the cost of production is based on the volume of production.
Price leadership model
There is only one company on the market, which sets the maximum barrier for the cost of production. Thus, the leading firm tries to increase its profits to the maximum possible. The remaining representatives of the market are only trying to catch up with the main competitor, while competing with each other. Here, an oligopoly is a series of non-cooperative companies, one of which completely controls the pricing of goods.
The leadership model is an integral part of a monopoly. When one firm controls both prices and profits, the others accept its terms of competition. In such a strategy, only large companies are leading. Information content in this model is missing. market dominance and high level demand - the main conditions of the oligopoly leadership. At the same time, the production costs of large firms are always reduced to a minimum.
The concept of the Cournot model
The strategy is based on a market duopoly. It was proposed back in 1838 by the French philosopher and mathematician Antoine Cournot. This oligopoly model has a number of advantages. Production is strictly regulated, pricing is standardized, the quality of services depends on technological equipment firms. This strategy also called healthy competition.
A duopoly is a market structure where there are only two sellers. They are protected from the emergence of new companies. Both competitors are producers of the same type of product, but do not have common denominators. A duopoly clearly shows how one seller outperforms another in the struggle for leadership under equal market conditions.
The Cournot model assumes that competitors do not have complete information about each other's plans and actions.
Market Power Theory
This strategy is aimed at regulating and setting prices for products. The sources of market power are the availability of substitute goods, the elasticity of cross-demand, temporary fluctuations in growth rates, legal barriers, monopoly on certain resources, technological equipment of competitors.
The main indicators of the strategy are the percentage of sales to output, the sum of the squares of sales shares, the difference between prices and costs.
Such an oligopoly market is always controlled by legislation to prevent the emergence of monopoly power.
An oligopoly occurs when there are a small number of firms in the market and barriers to entry are high.
Characteristic features of an oligopoly
An oligopoly is a market structure that has the following characteristics:
1) a relatively small number of firms;
2) barriers of different permeability that prevent new firms from entering the industry;
3) the product is homogeneous (for example, aluminum or steel) or differentiated (cars or drinks);
4) control over prices;
5) interdependence between all oligopolistic firms.
So, an oligopoly is characterized by a small number of firms (from 2 to 10), fenced with barriers that prevent new firms from entering the industry, have price control, but in collusion with other oligopolists.
The main feature of an oligopoly is that the number of firms is so small relative to the size of the market, each of the oligopoly firms recognizes a close relationship with each other. The theory of oligopoly is more complex than the theory of perfect competition, pure monopoly, or monopolistic competition. For example, a perfectly competitive firm only needs to equate marginal cost and marginal revenue. In the case of an oligopoly, things are not so simple. Since there is a general interdependence, the oligopolist earns marginal revenue by charging a higher price, depending on the response of competing firms. If their reaction is not provided, then the oligopolist will not receive marginal revenue (see Example 10.3).
Example 10.3
The Prisoner's Dilemma
The situation in an oligopoly with attempts to predict the behavior of competitors in the economic literature is explained by the example of two unlucky robbers. Two robbers at night with weapons went to rob a bank. However, almost at the bank, they stumbled upon a police ambush, and each of them ended up behind bars. Each of them was obliged to provide for the behavior of his colleague in misfortune: if they both "talk" - each receives 5 years in prison for attempted robbery; if only one "speaks" and the second remains silent, then the first one will be released, and the second one will sit down for 20 years; if both remain silent, then they receive 1 year for illegal possession of weapons. What should everyone do? As a rule, business comes to an end with that at first one, and then and the second robber "says".
General interdependence
An oligopoly is defined as a market with a relatively small number of firms, but each firm must take into account the response of competing firms. One firm must anticipate how competing firms will react to its actions, etc. If firms in an area need to consider the response of competing firms, then the industry is characterized by general interdependence.
So, general interdependence is the main feature of an oligopoly. The actions of one firm affect other firms in the industry. When deciding on prices, quantity and quality of a product, an interconnected firm needs to take into account the reaction of competing firms. The competitor firm, reacting to the actions of the first firm, must consider how the first firm will react to its actions.
In some oligopolistic industries, the type of reaction may be well understood by all participants; it may be dictated by custom or convention. In other industries, the response of competing firms may be unpredictable, and participants must use strategic behavior to anticipate and outmaneuver their rivals (see Exhibit 10.4).
Example 10.4
The collapse of the cocoa producers' organization
The International Organization of Cocoa Producing Countries (COCO), which was based in London, set its price for cocoa by buying excess cocoa whenever there was a threat to lower the price below the level it had set.
In 1977, cocoa prices were high: approximately $5,500 per 1 ton. Real profits of $5,500. for each ton, cocoa producers in the area could receive cash, but this real income acted as a magnet, attracting new producers to the market. Expecting high prices, new planters planted cocoa trees in countries such as Brazil, Côte d'Ivoire and Malaysia. As soon as new cocoa producers entered the market, the market price began to fall. but this lasted only until February 1988, when the volume of cocoa that was stored in warehouses reached 250 thousand tons. Since the international organization of cocoa producing countries could not keep the price at the same level, the price decreased to $ 1,600 per 1 ton.
The bankruptcy of an international organization of cocoa producing countries illustrates one of the key pricing problems of oligopolies: how to keep other producers out of the market when the price is high enough to generate monopoly profits.
Strategic Behavior
Firms A and B are oligopolists and they are interconnected. The profit of each firm depends on the price set by the other firm. Assume that the prices of two goods are the same and that both firms earn absolutely equal profits. If one of them lowers the price slightly, then, despite this, it will receive high profits, while the firm with a higher price will receive lower profits.
On fig. 10.5 presents possible results. Each company has the opportunity to choose the price: 20 or 19 UAH. Firm A's price choice is illustrated on the left side, and Firm B's is illustrated along the upper horizontal. The profits that Firms A and B earn depend on the prices they charge. Firm A's profit is shown in the lower left corner of each rectangle, and Firm B's profit is in the upper right corner. If firms set a price of UAH 20, then both receive UAH 2,500 each; if they set the price at UAH 19, then both receive UAH 1,500 each. If one firm sets the price at UAH 20 and the other at UAH 19, then the firm with the lower price receives UAH 3,000, while the firm with the higher price receives only UAH 1,000.
Rice. 10.5. Profit making by an oligopoly that consists of two firms
Each box (sector) shows the profit that firms receive at various combinations of prices that they themselves set. If firm A sets a price of 19, and firm B - 20 UAH, then firm A makes a profit of 3000, and firm B - 1000 UAH. What strategy should each firm follow?
It is clear that the oligopolist begins to receive high profits (at the expense of another firm) by setting a lower price, provided that the competitor maintains a high price. Both firms will earn less profit if both lower their prices. If both set a higher price, then each of them makes a larger profit. However, each oligopolist has to set the price without knowing what the other firm is going to do.
Reasoning governs the price decisions of the oligopolistic firm? These may be assumptions about how the competitor firm will react. The reasoning could be something like this: "My competitor will not dare to set a higher price - 20 UAH, fearing that I will set a low price - 19 UAH. Thus, if I set a high price - 20 UAH, I will receive only 1000 UAH., And if I choose a lower price - UAH 19, then I will get UAH 1500. So, I will set a low price - UAH 19". If a competing firm thinks the same way and decides to charge a lower price, it turns out that both firms correctly predicted each other's actions and chose the appropriate strategy.
In such a situation, both firms would decide to set the price at UAH 19 and would make a profit of UAH 1,500 each. However, they know that if they bid UAH 20, they could make a profit of UAH 2,500. If firms A and B made the same price decisions over the long run, then it is likely that they somehow knew that they would get richer if they set prices higher. Firms could learn to cooperate and choose a strategy (price 20 UAH) that maximizes the profits of both. There is another method by which both firms decide to set a price of UAH 20 - they could agree that both set a high price.
Oligopoly based on collusion
If oligopolists have learned to cooperate, then they begin to receive high incomes. Conspiracy within an oligopoly can take many forms. Oligopolists can secretly agree on prices and output volumes. They can officially register this in a secret transaction (but such agreements are illegal) or open (provided that such agreements are legal and even agreed with the government of the country). A conspiracy can be carried out in a free form, that is, on the basis of customs and traditions, or in the form of an informal agreement. The effectiveness of such collusion is different for different oligopolies. In some cases, the conspiracy is quite reliable, and in some cases it is fragile and tends to collapse.
Cartel
For an oligopoly, a simple means of coordinating pricing and output policy is to form a cartel that obliges all parties to set certain prices and a certain market share for each producer. With any luck, such an agreement will allow oligopolistic firms to receive monopoly profits in the industry as a whole.
So, cartel is an agreement by which the oligopoly companies coordinate the volume of output and pricing in order to obtain monopoly profits.
On fig. 10.6 illustrated an oligopolistic industry that consists of three firms (which produce the same product at the same cost). Each of the three firms agrees to 1/3 of the market and sets the same monopoly price. Since all three cartel member firms have agreed to divide the market equally, then Firm A's demand will equal 1/3 of the market demand, etc. Firm A's monopoly price lies at the intersection of the marginal revenue curve with the marginal cost (MC) curve. With such a demand curve, firm A will maximize its profit by producing 100 units of goods at a price of 50 UAH per unit. Other 2 firms also offer the price of 50 UAH. and produce 100 units each. The volume of output in the whole industry is 300 units. (100 o 3).
Firm A, however, is tempted to deceive rivals. While two other firms are selling 200 units at a price of 50 UAH, firm A could set a price of 49.5 UAH and sell slightly more than 1/3 of the market. The price of UAH 49.5 undoubtedly exceeds firm A's marginal cost (UAH 20). The actual real income will go to the firm that violates the agreement. Firms B and C are prone to the same temptation. If they "cheat" for a short time (and no one else does the same), they can increase their income. Violation of the agreement is a cost for them in the long run. If other firms discover the deception, they break the agreement. As a result, a price war may flare up and economic profits will decline.
Lust for profit underlies the creation and collapse of cartels. Cartels bring a part of the monopoly profit to their members for as long as each of them adheres to the cartel agreement. However, each of the members of the cartel can make large profits by fraud, provided that others do not cheat. Cartel members face a dilemma. If one "cheats" and the other does not, then the "cheater" wins. If both are playing a dishonest game, then both lose. If both will abide by the agreement, then such a provision is beneficial for them than the option when one "cheats". But each of them is prone to deceit.
Cartels are unstable because it's hard enough to force agreements on someone. Very few cartels are successful over the long term. Most of the cartels that were involved in the sale of sugar, cocoa, coffee, quickly disappeared or did not have a significant impact on prices. There are many examples of cartels that are based on pricing agreements. Representatives of the states that are members of the Organization of the Petroleum Exporting Countries (OPEC) regularly hold meetings that are widely covered by the world press. They are held to harmonize oil prices. Thus, the International Air Transport Association also holds open meetings with the consent of the governments of the participating countries.
Many cartels come and go despite the fact that the government provides them with legal assistance. They, as historical experience shows, are traditionally unstable, since it is very difficult to force someone to collude. The thirst for profit leads to the fact that the cartels disintegrate. Very few cartels operate successfully over the long term. Even the most successful cartel in history, OPEC, has failed to set a strictly monopoly price. There are too many temptations for its members (especially those who need cash) to break the agreement.
Barriers to Conspiracies
There are many obstacles that reduce the chances of an effective and credible conspiracy within the cartel. Competitive struggle between cartel members intensifies when there are:
1) a large number of sellers;
2) low barriers for new firms to enter the industry;
3) the presence of a differentiated product;
4) high rates of scientific and technological progress;
5) high fixed costs and low marginal costs;
6) legal restrictions (for example, antitrust laws). A large number of sellers. The more sellers or firms in
industry, the more difficult it is to create a reliable cartel. With a very large number of members, it is quite difficult to establish contacts between participating firms. Small firms that have signed an agreement are more susceptible to the temptation to break it: not only are they less well-known than large firms, but they can also suffer from megalomania.
Low entry barriers for new firms in the industry. If new firms can easily enter the industry, then existing firms will not want to enter into deals to increase the price. With sufficiently free access to the industry, prices cannot be significantly higher than the cost of production.
The presence of a differentiated product. The more diverse or differentiated the goods, the more difficult it is to come to an agreement in such an industry. Reaching an agreement can be both unprofitable and profitable. Achievements will be more unprofitable in the presence of a differentiated product. For example, steel is homogeneous and agreement on prices and market share among steel corporations can be easily reached. But it is quite difficult to conclude an agreement between aircraft manufacturers on prices for the DC-10 and Boeing-747 due to a discrepancy regarding quality.
High rates of scientific and technological progress. With the high rate of scientific and technological progress, a conspiracy may not be possible, since industry is now constantly releasing new products and developing new technology. A firm that uses an innovation can make more profit than within a cartel. It is difficult enough to imagine the existence of a conspiracy between Kodak and Polaroid or IBM and Apple.
High fixed costs and low marginal costs. Higher fixed costs associated with total costs, marginal costs are usually low. The temptation to "cheat" in a cartel is a function of the difference between price and marginal cost. Thus, relatively high fixed costs encourage certain cartel members to "fraud".
Legal restrictions. The Sherman Antitrust Act (1890) in the US says that associations intended to restrict trade are illegal. Such legislation can certainly prevent conspiracies and thus price increases from cartels.
Since each industry is marked by product differentiation, entry conditions, number of firms, relative rates of marginal and fixed costs, rates of technological progress, the degree of oligopolistic coordination cannot be the same. So, some oligopolies, unlike others, can enjoy almost monopoly power.
Understand that an oligopoly (from the Greek oligo - few and poleo - sell) is a market structure dominated by a few large firms, i.e. a few sellers oppose many buyers. Although there is no clear quantitative criterion for an oligopoly, there are usually 3-10 firms in such a market.
According to the type of product, a pure oligopoly is distinguished - an oligopoly that produces a homogeneous product (cement, mineral fertilizers, products of the steel industry), and an oligopoly producing differentiated products (cigarettes, household appliances, cars).
Firms operating in an oligopolistic market earn high profits because, as in the case of a pure monopoly, it is difficult for outsider firms to enter the industry. The barriers to entry for newcomers to the industry are the same as in a pure monopoly: economies of scale, ownership of patents and licenses, control over sources of raw materials, and so on.
An oligopoly has the following features:
1. A small number of firms in the industry, when a few firms can control the bulk of the market, producing both homogeneous and differentiated products.
2. High barriers to entry into the industry.
3. Large interdependence of oligopolistic firms with each other both in terms of price and output.
4. Price controls are either limited or significant when colluded by competing firms.
Since the oligopoly includes a small number of enterprises, they depend on each other in their activities - each of them owns a significant market share and can influence prices. Therefore, a characteristic feature of the oligopolistic market is the interdependence of firms. Any of the oligopolists is significantly influenced by the behavior of other firms and is forced to take this dependence into account. On the one hand, the market behavior of each individual seller affects the sales of his competitors, causing a corresponding reaction from the latter. On the other hand, the behavior of other firms affects the behavior of this competitor.
There are four options for the existence of an oligopoly and the interaction of its members in pricing: an oligopoly not based on collusion; interaction due to a secret agreement; leadership in prices; pricing based on the principle of "cost plus ..."
In modern conditions, the most common oligopoly is not based on collusion. This is due to the fact that almost everywhere there are antitrust laws, and they are quite severe.
Oligopoly is the predominant market structure of the modern economy, since it accounts for most of the output.
Features of the behavior of an oligopolistic firm in the market. In particular, understand that in the short term, it is able to maintain the price of its products. This is due to the firm's preliminary readiness for a possible fall or increase in demand. The oligopolistic firm is ready (and has the ability) to change (mothball or introduce) in accordance with the changed demand a certain amount of individual fixed resources - machine tools, machines, equipment, stocks, etc. At the same time, it can change the amount of the variable factor (labor), leaving this value, its change per unit of output is constant. We can say that in the short run there is a constant return to scale of production with a change in output.
In this period, the oligopolist, based on market research, determines his normal demand curve, taking into account which he specifies how much of the product can be sold at the appropriate price. Knowing the potential demand, the firm prepares the factors of production, taking into account possible changes in demand. An oligopolist, like other imperfectly competitive firms, maximizes its profits when equality is maintained. MR=MC, while the curves AVC and MS match.
In the long run, the actions of an oligopolistic firm are determined by the reaction and response of competing firms. The dependence of the behavior of each oligopolistic firm on the reaction of competitors is called the oligopolistic relationship. The firm must carefully consider the possible actions of its competitors in the oligopolistic market when the price and output of its products change.
The presence of oligopolistic relationships determines the complex nature of the behavior of firms. One firm assumes that competitors will always support a general decrease in the price of an industry's product, but will not support its increase. Another firm might assume that each firm will respond to a change in the price and output of its competitors, but not to a change in its own volume and price. The third firm expects the worst possible from its competitors, acting in accordance with these expectations.
Given that in the long run, the actions of oligopolistic firms can be multivariate, there is no unified theory of oligopoly. However, economists have developed models that take into account a number of coordinated actions of competing firms with changes in prices and output volumes in the oligopoly market.
One such model is the Cournot model. The essence of this model is that of two competing firms (duopoly), each takes the volume of production of its competitor as constant and, based on this, determines its own actions for the production of products. Comparing the reactions of oligopolistic firms to each other's behavior, they determine the value of the proposal, which is the same for each firm. This is the so-called Cournot equilibrium. With such an equilibrium, the firm can determine how much output a competitor will produce and, depending on this, maximize its profit.
Thus, at Cournot equilibrium, one of the firms sets the output and “takes away” part of consumer demand, assuming that the second one “give up”, reducing the price and output, i.e. the second firm accepts the conditions of the first firm. However, the behavior of the second firm may be different when it does not accept any conditions and declares a price war in order to prevent a competitor from entering the market. At the same time, the second firm does not reduce output and significantly reduces the price of its products.
Given the great dependence of the oligopolist on the actions of other firms, when analyzing an oligopolistic situation, game theory is used - a science that studies the possible behavior of a participant in probabilistic situations related to decision making. Such situations are probable lines of behavior of oligopolistic firms, evaluating which one can foresee one's own possible solution. For example, firms are the only sellers in an oligopolistic market. At the same time, each firm can raise or lower the price.
If firms leave prices unchanged, then both of them do not make a profit. At the same time, if both reduce the price, then each can receive a loss. If one firm leaves the price unchanged, while the other lowers the price of its products, then the first firm will suffer a loss, and the second firm will make a profit by the same amount. And vice versa.
How should competing firms proceed in this situation? Even if the firms try to negotiate to leave prices unchanged, each firm tends to break the agreement, because this promises it a solid profit. At the same time, under these circumstances, the firm that fulfills the agreement may receive a loss. It would be reasonable for each firm to reduce the price, losing in this case much less than if its competitor could lower the price. This situation is called the prisoner's dilemma.
A characteristic feature of the described situation is the adoption of a decision that is contrary to selfish interests, but more realistically assesses the possible moves of a competitor, i.e. firms lower the price, although there is an option not to do so. Such a strategy is called the strategy of least loss, when the firm does not fully trust its competitor.
Since the actions of oligopolistic firms affect financial results each firm in the industry, then between them there is a real opportunity to agree on the size of the price of the goods, on the amount of output, on the division of the market, on limiting the admission of other firms to it, etc. Collusion is an agreement between firms to develop a common market policy. When oligopolists officially agree on prices and volumes of output, the result of the agreement is the association of firms into a cartel.
One form of implicit collusion is price leadership. This phenomenon is most often observed in an industry where there is a dominant influence of one, as a rule, the largest leading firm. Such a firm acts as the initiator of possible changes in prices and output. The price leader is confident that other firms will follow suit. Oligopolistic firms in an industry know that if they follow the leader, others will do the same. Such coordination is tantamount to a cartel, although there is no formal agreement. It should be noted that the firm-price leader operates not only along the line of raising prices. To prevent competitors from entering the industry, the price leader may also lower prices, thereby declaring a price war.
The considered models allow us to assert that the behavior of oligopolistic firms can be of a multivariate nature. Firms that coordinate their behavior can act as monopolies, with prices above marginal cost, earning high profits. Some firms may act as competitors, with prices equal or close to marginal cost.