Question

Show in a graph how an Oligopoly will create an artificial shortage and by doing so what does that do to price? Make a comparison between the differences between an Oligopoly and firms in Perfect Competition, Monopolies, and firms that are in Monopolistic Competition. How are they the same but how do each differ. How does the number of firms in an Oligopoly affect its outcome on Price, Product, Place, and Promotion? Which of these 3 will an Oligopolistic frim not compete on and which of the other will be a sure thing that it will compete and describe some tactics it might use. Give 2 examples of Oligopoly firms where you see game theory played out.

Answer 1

The most common type of artificial scarcity that comes to one's mind is that formed through Cartel. For example, the Oil and Petroleum Exporting Countries (OPEC) which is an intergovernmental organization consisting of oil exporting countries boasts of the fact that its true strength lies in holding back a huge quantity of cheap oil. This deliberate holding back of cheap oil supply is known as artificial shortage because this shortage is man-made and even though supply is very much possible, the oil is hoarded to make it appear as if it is scarce. The direct impact of this artificial scarcity is on the price of oil, which shoots up when supply is reduced. As a result, profit margins rise exponentially. This is clear from Fig 1 which shows that output is restricted to Qo level of oligopoly output such that the price becomes Po instead of Pc. This Po lies between Monopoly Price (Pm) and Pc. The output that could have been sold is Qc, lying to the right of Qo. As the number of firms under Oligopoly rises, it moves closer to perfect competition and the oligopoly output moves closer to Qc. However, here, the artificial shortage is of the quantity Qc-Qo. The Demand curve is the average revenue curve (AR) and the marginal revenue curve (MR) lies below it. The Marginal cost curve (MC) is upward sloping.

There are four types of markets, namely: Perfect Competition, Monopolistic Competition, Oligopoly and Monopoly. Some characteristics of Oligopoly markets are similar with that of the rest, however, there are notable differences which set one apart from the other. The first comparison is done between Perfect competition and Oligopoly.

Oligopoly vs Perfect Competition:

The only visible similarity between these two types of market is that perfect competition always sells homogeneous (identical) products and Oligopoly too has an option of selling homogeneous products. In that case, it is known as 'Pure Oligopoly'.

There are a large number of differences between these types of markets:

• Perfect competition has a very large number of sellers as opposed to a few big sellers under oligopoly.
• Perfect Competition is a price taker because of no market power of any firm to influence the price. Oligopoly is a price maker because the few sellers enjoy significant market power.
• Perfect knowledge is a characteristic of Perfect Competition as opposed to imperfect knowledge of the market under Oligopoly.
• No selling (advertisement) costs are incurred on homogeneous products under perfect competition. For Oligopoly branding and selling costs are huge.
• Lastly, there is complete freedom for entry and exit of firms from Perfect Competition which is not there in case of Oligopoly.

Oligopoly vs Monopolistic Competition:

The similarities between Oligopoly and Monopolistic competition are as follows:

• Monopolistic competition sells differentiated products and oligopolists have the option of selling differentiated products under 'differentiated oligopoly'.
• Both these forms of markets are price makers. Oligopolists have a fair share of market power whereas monopolistic competition boasts of differentiated goods to charge different prices.
• Both these forms spend a lot of money on selling costs associated with branding and advertising their products.
• Both these types of market have imperfect knowledge.

The differences between the two can are:

• Monopolistic competition has a large number of sellers as opposed to a few big sellers under oligopoly.
• there is complete freedom for entry and exit of firms from Perfect Competition whereas Oligopoly faces barriers to entry.

Oligopoly vs Monopoly:

Lastly, a comparison between Monopoly and Oligopoly can be made. These forms of market have the following similarities:

• Both these forms face barriers to entry which restricts the entry of new firms into the market. In Oligopoly the entry of a firm is very difficult but still possible. In case of Monopoly, the entry of new firms is next to impossible.
• Both these forms of markets are price makers.
• Monopoly and Oligopoly have imperfect knowledge as another common characteristic.

However, these two forms of market are also quite different from each other:

• The number of sellers is different wherein monopoly has a single seller but oligopoly has a few sellers.
• The nature of the product is such that there are no close substitutes for Monopoly whereas there might be room for substitutes under Oligopoly.
• Under monopoly, only informative selling costs are incurred to inform consumers about the availability of the product. Under Oligopoly, huge selling costs are undertaken for branding and advertising each of their products.

The number of firms in an Oligopoly affects the outcomes on price, product, place and promotion differently.

As the number of firms goes on increasing, the competition moves from Oligopoly towards perfect competition and price starts to reduce. On the other hand, as the number of firms fall, output reduces and the price of the product starts increasing.

As the number of firms increases, there is a need to differentiate the products more and more to attract consumers to a particular firm's products. If there are 2 firms selling identical products, the consumer will be indifferent regarding which producer to buy it from provided they are selling at the same price. On the other hand, if those very 2 firms sell differentiated products, the consumer will be offered more variety and would be willing to pay different prices for the two goods and wouldn't be indifferent regarding the purchase anymore.

As the number of firms go on increasing, the place or location of the firm becomes very crucial. This in turn depends on the nature of the product. If firms are selling differentiated products, then it doesn't matter if they are situated close to one another. However, if number of firms selling homogeneous products increases, should be located far away from each other in order to attract customers properly.

Lastly, as the number of firms largely affect promotions. As the number of firms increases, there is competition among the firms to sell its product by beating the sale of its rival firms. As a result, promotion and branding is very important for customers to be attracted to a particular producer’s product over the rivals. Thus, as number of firms under Oligopoly rises, promotions rises.

Out of these characteristics, an Oligopoly will compete in Prices and not on the type of product, the place of sale or the promotion of the product. Usually, Oligopolists compete in either Quantity of output (Cournot Duopoly, Stackleberg etc) or in Price of product (Bertrand).

• While competing in prices, one of the few tactics that the firm can use is under-cutting the rival firms' prices to grab a higher share of the market.
• When the firms acre competing in prices, they sell homogeneous products, otherwise price-competition makes no sense.
• The firms under-cut each other's prices until each firm's price equals its marginal cost of production. This is known as the Bertrand Paradox because in spite of being Oligopolists and having market power, the firms end up selling at the competitive price (equal to MC) and earn zero profits.
• Also, if one firm has a lower average cost than the other, then it'll set a price of product, above its cost but just below the cost of its rival firm in order to capture the whole market share. This price is known as 'limit price' which is the price below which no producer is willing to sell his/her product.

Oligopoly is a synonym for strategic interaction among firms where each firm's action affects the action of its rival firm. Thus, this takes the form of game theory where each firm's reaction depends on the strategy of its rival firms and vice versa. Two such examples of Oligopoly playing according to game theory are:

Coca-Cola vs Pepsi, the two giants of the soft-drinks industry with slightly differentiated products. If Coca-Cola is taken as the row player (Player I) and Pepsi as the column player (Player II) then their payoff matrix can be given as follows:

Payoff Matrix
	Advertise more	Advertise less
Advertise more	8, 8	9, 2
Advertise less	2, 9	6, 6

Here Pepsi and Coca-Cola has two strategies to choose from- either to advertise more or to advertise less.

Similarly, McDonalds and KFC can be two other Oligopoly firms competing in burgers. Here McDonalds is taken as the row player (Player I) and KFC as the column player (Player II) then their payoff matrix can be given as follows:

Payoff Matrix
	Offer a sale	Don't offer a sale
Offer a sale	10,10	12, 6
Don't offer a sale	6, 12	8,8