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Tuesday, May 24, 2011

Emergence of Oligopoly in Economics from

Emergence of Oligopoly in Economics

An Oligopoly is a market structure with a small number of firms. A good example of an oligopoly is the petroleum industry in which a few firms have accounted in recent years for much of the industry’s refining capacity. Each of the major oil firms must take into account of the reaction of the others when it formulates its price and output policy is likely to affect theirs.

Oligopolistic industries like others, often pass through a number of stages – introduction, growth, maturity and decline. The industry’s sales grow very rapidly in the introduction phase, less rapidly in the growth phase and even less rapidly during maturity. In the stage of decline, the industry’s sales fall. As an industry goes through these stages the nature of competition often shifts.

During the early stages of Oligopoly when industry sales are growing relatively rapidly, there frequently is a great deal of uncertainty about the industry’s technology. Which product configuration will turn out to be the best? Which process technology will be most efficient? Because of small production volume and the newness of the product, production costs tend to be higher than those that the industry will eventually achieve.

At an early stage of an industry’s evolution in Oligopoly, one of the major strategic questions facing managers is: which markets for the industry’s new product will tend to open up early and which ones will open up relatively late? This question is important both because firms should allocate marketing efforts and R&D resources to relatively receptive markets and because the nature of the early markets can exert a significant influence on the way the industry evolves. To forecast which markets or market segments are likely to be most receptive to a new product, one should consider some factors.

Most of the receptive buyers tend to be those for which the new product is most profitable. For example, if a new robot is much more profitable in the railroad industry than in the agricultural equipment firms. It is more likely to be used first by railroads, not by agricultural equipment firms.

Buyers who face a relatively low cost of product failure are likely to be quicker to adopt a new product than those for which the potential costs are very high. Thus, if the new robot could cause millions of dollars of losses in the auto industry but only minor losses in the steel industry, it is more likely that steel producers will take chance on it than that auto firms will do so.

The buyers who would experience relatively low costs in switching from old products to new one sold by this industry are likely to be more receptive to this industry’s product than buyers who would experience high changeover costs.

Eventually, most industries enter the maturity phase, when industry sales grow much more modestly then before. This is often a critical phase for many members of the industry. Since firms cannot maintain the growth rates to which they are accustomed merely by protecting their market share, there is often a tendency for firms to attack the market shares of their rivals in the same industry.

During the maturity phase, rivalry among firms often centers on cost and service, rather than new or greatly improved products. Because of slower growth, more knowledgeable customers and greater technological maturity, competition tends to focus on cost and service, which may prompt a significant reorientation of firms that have competed on other grounds in the past. Also, as the industry adjusts to slower growth, there generally is a reduction in the additions to productive capacity. Often, firms do not realize that they have entered this maturity phase until after they have installed more capacity than is required. Thus, for a time, the industry suffers overcapacity.

After the maturity phase, many industries enter a stage during which sales decline. One reason for such a decline may be that the product is being supplanted by a new one. Another reason may be shrinkage in the size of the customer group that buys the product, perhaps because of demographic changes. Still another reason may be a change in buyers’ tastes and needs.

Although firms in declining industries are often advised to curtail investment and get lots of cash out of the business as quickly as possible this is not always the best strategy. Some industries, like some people, grow old more gracefully and profitably than others. Some firms have done well by investing heavily in a declining industry, thus making their businesses better “cash cows” later. Others have avoided losses subsequently experienced by their rivals by selling out before it was generally recognized that the industry was in decline.

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This article is in continuation with our previous articles on Economics which include Inflation, Business Cycles, Solow's Growth Model, Phillips Curve

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