Uncertainty: The basic nature of Oligopoly
By Paramantapa Dasgupta
Recently, in one of my articles, I’ve very briefly described the basic nature of Oligopoly. (http://www.articlesbase.com/business-articles/oligopoly-competition-among-the-few-219172.html)
So not going into that deep, in this article I want to portray the most exciting virtue of Oligopoly, that is, Uncertainty.
It’s really striking when we see that in the verticals like manufacturing or brewing or even today’s software industry, the most common market orientation is oligopoly, means a battle amongst few and the business decisions are uncertain. Tough to believe but it’s a fact.
Before going extreme into it, let’s take two examples of business decisions under perfect competition and monopoly. Under perfect competition, number of seller is huge so it’s not practically possible for a single seller to dictate the selling price and hence the demand curve prevailing in the industry stays unaffected. So a firm under perfect competition faces a perfectly elastic demand curve at the level of current price in the market. On the contrary, a monopolist produces a product which is having a remote substitute. So he can easily neglect the effect of changes in the product prices of his remote competitors in a market. Even if we go beyond and think about monopolistic competition, still one can find under monopolistic competition, change in the price of one seller’s product can hardly make any effect on the other sellers’ pricing decisions.
But the situation under oligopoly is totally different from the mentioned examples. This is due to the presence of interdependence of the firms into it. Under oligopoly, a firm can not assume that its rival will keep their prices unchanged when it makes change in its own price. So the demand curve facing an oligopolists looses its definiteness and as well as its own significance. It goes on constantly shifting as the rivals change their prices in reaction to the price changes by that firm.
The significance of the interdependence between the firms may generate a wide variety of outcomes according to the changes of business propositions in the market. Firms may decide to get together and co-operate in the pursuit of their objectives, or to the other extreme, they may try to fight each other to the death. Even if they may get into some kind of agreement but there is hardly any guarantee that it will last or it will break down. So in reality it’s a real tough job to predict future business in oligopoly.
When an oligopolistic firm changes its product price, its rival firms retaliate or react and change their prices which in turn would affect the demand of the former firm. More over, there is quite uncertainty about the rivals’ reaction to a price change by one firm. That is, say firm “A” cuts down its product price but firm “B” or “C” may keep their prices unchanged or may cut off too. If they cut their prices, whether they will cut it by the same amount or by smaller or greater amount, on that part “A” is absolutely clue less. A definite and determinate demand curve can only be drawn once the rivals’ prices remain unchanged or it is known beforehand that they will change their prices in a certain particular way in response to the price change by the former firm.
Now, think yourself as that oligopolist A. To retain and increase your client base, you’ve cut down your product price and still you don’t know which demand curve you are going to confront. This means the probable required output level, as the owner of the firm, you do not know. Only you can make a wild guess on that and again depending on the past reactions of your rival firms. So what will you do?
Economists have found out four different ways to come out from that dilemma.
First one is very easy and bit impractical too. Just ignore the interdependence. And once you will do so, your demand curve will become determinate.
Second approach to provide a determinate solution to the price and output is to assume that firm “A” can predict the reaction pattern and counter moves of his rival firms. Though at the first cut, it also looks very naïve idea but firm “A” can get at least one assurance , that the rival firms may follow the same reaction, if he cuts down the product price but a price increase shall not be followed by them. So at least with this second proposition some kind of visibility may come into the mind of “A” to draw the pattern of the demand curve.
The third approach is bit tricky but this is a good alternative. The rival firms, realizing their interdependence, will pursue their common interest and will form a collusion, formal or tacit ; that is the firms will enter into an agreement and can work accordingly. Now they can maximize the joint profits and share the profits or market as agreed between them. A variant of this notion can be one firm may think himself as the leader (it should be a low cost or a dominant firm) and other firms can follow him in fixing the price and output.
Forth approach is the most modern one and probably the most interesting too. This is also known as “Game Theory” or “The Theory of Games”. Here firm “A” does not guess at its rivals’ reaction pattern, but calculates the optimal movements by the rival firms, that is, their best possible strategies and in view of that, it adopts its policies and counter moves.
So Mr. “A”, now it is absolutely your call to choose the best possible alternative to counter your rivals’ strategies. But still for the reason I personally like Oligopoly most is due to its hidden mystery, excitement and uncertainty. After all, our entire world is really chancy, very chancy. Isn’t it?
A student of Economics . Presently engaged with the Software Industry in India.
