9.4 Oligopoly
Main Topics: Structural Characteristics, Industry Concentration, Game Theory and the
Prisoners’ Dilemma, Collusive Pricing
Oligopoly markets are typically further from perfect competition than the monopolistic
market structure, although there is no one model of oligopoly. A couple of oligopoly models
are presented, but keep in mind that if one little assumption is relaxed, the predictions of the
model can be radically different. For the AP exam you will likely face only these basics.Structural Characteristics
You can see from these characteristics that oligopoly shares more common ground with
monopoly, but these are flexible enough to describe many different and diverse industries:- A few large producers.Can it get more vague than this? Think of the American auto
industry, with the “Big 3” producers, or the tobacco industry, also dominated by three
huge firms. If the distribution of market share in an industry is top-heavy with a few
large firms, the industry is described as oligopolistic. - Differentiated or standardized product. Oligopoly industries can come in both flavors.
Crude oil is a fairly standard product, but it is very much an oligopoly of large producers.
Automobiles, beer, and soft drinks are also oligopoly markets, but with more differenti-
ated products. - Entry barriers. If these industries were fairly easy to enter, we would not see them dom-
inated by a few huge producers. - Mutual interdependence. Because a few large producers control these industries, the action
of one firm (price setting or advertising) is likely to affect the others and prompt a response.
A good example of this is your local gasoline market. This is very much an oligopoly; when
one gas station lowers prices by one cent per gallon, the others usually quickly follow.
Industry Concentration
How does an industry become classified as an oligopoly? Economists have tried to get more
specific than a “few large producers” by developing ways to measure how much market
share is held by, or concentrated in, the largest of the firms. One way to gauge how power-
ful the largest of firms might be is to sum up the market share of the top 4, or 8, or 12 firms
and create a concentration ratio. If the top four firms in the breakfast cereal industry have
a combined market share of 85 percent, we say that the four-firm concentration ratio is 85.
Some economists use a four-firm concentration ratio of 40 percent as a rough guideline for
identifying an oligopolistic industry. We predict that as this concentration ratio increases,
the degree of monopoly price-setting power increases.Game Theory and the Prisoners’ Dilemma
Imagine a case where a two-firm oligopoly (a duopoly) engages in a daily pricing decision.
Each firm knows that if it sets a price higher than the rival’s, it loses sales. Likewise, if it sets
a price below the rival’s, it steals sales. This non-collusive model of pricing, called the pris-
oners’ dilemma,emerges from the following scenario that any fan of Law and Order
quickly recognizes.Example:
A college professor suspects two students (Jack and Diane) of cheating on a take-
home final exam, but she cannot prove guilt with enough certainty to fail both
students in the course or expel them from the school. Without a confession, she
will give each student a D in the course. With a confession from one student but134 › Step 4. Review the Knowledge You Need to Score High
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