When a market is dominated by a small number of large companies, it is referred as an oligopoly. The exact number of companies that is needed to create oligopoly is in range between 2 and 9, but the type of oligopoly that includes two companies is referred as duopoly.
Even thought, managing company under other market situations like monopoly bring its own risks and difficulties, from the management position, oligopoly is considered the most challenging to manage and handle because the actions of the other companies directly affects the decisions that manager brings. Complexity of oligopoly is held in dependence between decision that companies bring and in which decision brought by one company directly affects the decisions brought by other companies.
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Decisions that manager brings that consider prices, must be thoroughly analyzed because of the effect on other companies. It can be explained in a way that if one company lowers their prices and the other companies do not, the company that have lower the prices will have an increase in sales, on the other hand if the other companies lower the prices also the sales will not be affected.
The example in chart 1 shows the example what will happen with the sales if the competition does not and does lower the prices.
PriceChart 1
Situation 1
Quantity
Sold
Situation 2
In situation 1 if the company lowers the prices and the competition does not match the prices, the quantity of goods sold will rise and that will affect the profit in a certain period of time.
In situation 2 if the company lowers the prices and the competition matches those lower prices there will not be a change in quantity of goods sold and profit.
In oligopoly there are four different types known as Sweezy oligopoly, Cournot oligopoly, Stackelberg and Bertrand oligopoly.
The Sweezy oligopoly consists of a presumption of actions that will other companies take if one company lowers or raises the prices which will eventually have an effect on quantity of the goods distributed. Characteristics that a certain industry must have to be identified as an Sweezy oligopoly are that there are no companies in the market that are serving many consumers, the companies produce differentiated products, each company believes rivals will cut their prices in response to a price reduction but will not raise their prices in response to price increase and barriers to entry exists (Baye 318). In this kind of oligopoly competitive companies expect one company to either raise or lower the prices but they will in most cases rather follow the price reduction than price growth. There are certain flaws in Sweezy`s oligopoly and the most important is the one that this model does not indicate how the competitive companies set the starting price. Even though, Sweezy oligopoly gives a view to strategic relations among the companies and management`s predictions for competition`s future actions that consider price changes. The real world example of Sweezy oligopoly can be shown in pharmaceutical industry. In pharmaceutical industry there are a small number of companies that produces distinguished products. Every company is sure that their competition will adapt to a price decrease. Some companies produce a new drug that are protected by a patent and in a short term that is considered as monopoly but with an expiration of that patent, other companies produce generic drug which lower the price of original one, so all of the companies set a similar price as competition, and they observe what moves will competition do in order to grab a bigger piece of the market.
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The Cournot oligopoly does not address the issue of prices, in this type of oligopoly the competitive companies must decide the quantity of output. Cournot oligopoly is when there are few firms in the market serving many consumers, when the firms produce either differentiated or homogeneous products, when each firm believes rivals will hold their output constant if it changes its output and barriers to entry exist (Baye 320). Managers in Cournot model bring choices that will affect the total output and they hope that their choices will not affect the choices of the competition. In order to apply Cournot oligopoly model, the products on a marker must be either the same or segregated. A situation in which neither company has an incentive to change its output given the other companies output is called Cournot equilibrium (Baye 322). The real world examples for Cournot oligopoly are the OPEC countries in which those countries decides how much oil they will produce because the amount of oil produced affects the price of oil in the market.
In Stackelberg oligopoly among the competitive companies there is a company that brings the first decision for increase or increase in output. After the decision is being made other companies follow the example of the leader company and adjust their outputs to maximize their profits. Characteristics needed for a certain industry to be identified as Stackelberg oligopoly are that there must be a few companies serving many consumers, companies produce either distinguished or similar products, a single company chooses output before all other companies choose their outputs, all other firms take as given the output of the leader and choose outputs that maximize profits given the leader`s output and barriers to entry exist (Baye 332).
In Bertrant oligopoly companies sell completely the same products. The certain characteristics that identifies Bertrand oligopoly are when a few firms in the market serving many consumers , the firms produce identical products at constant marginal cost, firms engage in price competition and react optimally to prices charged by competitors, consumers have perfect information and there are no transaction cost and barriers to entry exist (Baye 336). Bertrand oligopoly generates zero economic profit and it acts the same as perfectly competitive market
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