1.2.4 - Oligopoly, collusion and competition

Few dominant firms

An oligopoly contains rivals, but each major rival is large enough for its decisions to matter to the others.

There may also be many small suppliers, but most sales belong to the few dominant firms. The relevant issue is dominance rather than an exact universal number of firms. In an illustrative market with three major phone manufacturers, one manufacturer's promotion may take enough sales from the others for them to respond.

The firms often sell different, or differentiated, products: their products perform similar functions but vary in design, quality, branding or service. Brand loyalty can give each supplier some pricing power while still leaving consumers alternatives. They are not necessarily selling an identical product.

Barriers to entry, such as expensive research, strong brands and high start-up costs, protect the large firms from new rivals. These do not mean entry is impossible, but a newcomer may need substantial finance and a convincing reason for customers to switch.

The firms are interdependent: each considers how rivals may react. A price cut can attract buyers, but competitors may match it. That anticipated reaction helps explain price wars, non-price competition and possible collusion without needing an advanced mathematical model.

Price and non-price competition

Oligopolists can try to win customers by changing price or by improving what customers receive.

Price competition includes cutting a selling price, offering discounts or temporarily reducing subscription charges. A firm expects a lower price to attract sales, but if rivals match it, the gain in market share may be small. Repeated matching cuts can create a price war. Consumers may enjoy lower prices during the war, while firms' profit margins shrink. A weaker firm might eventually leave, reducing future competition; low prices today do not ensure low prices forever.

Non-price competition includes product design, quality, advertising, after-sales service, convenience and loyalty schemes. An illustrative appliance manufacturer may offer a longer warranty rather than a lower price. A buyer who values reliability may switch even if the selling prices are equal. Improving features or service can create value, although marketing costs can raise costs and persuasive advertising may shift demand without improving the product itself.

A firm chooses between these methods partly by predicting its rivals' responses. A price cut may be quick to copy, whereas a distinctive product design or trusted service can be harder to imitate. Competition can therefore continue strongly even when posted prices change little. Stable prices alone are not proof that firms have agreed to cooperate.