Introduction
A market with few sellers is known as oligopoly market. It is a form of imperfect competition. The simplest form of oligopoly occurs when there are two sellers in the market. It is called as duopoly. The product produced and sold by the firms in an oligopolistic industry may be homogenous or differentiated. If the product produced is homogenous it is called pure oligopoly and if the products produced are differentiated then it is called differentiated oligopoly. Oligopoly is the most prevalent form of market organization in the manufacturing sector of United Sates and other countries. Some of the oligopolistic industries in United States are cigarettes, beer, aircraft, breakfast cereals, automobiles, tires, soaps, detergents and many others. Among them some are homogenous like steel and aluminium while others are differentiated like cigarettes, beer, breakfast cereals, soaps etc. Cereals being eaten everyday at breakfast in America we will consider this industry for showing the characteristics of oligopoly industry.
An Oligopoly market consists of small number of interdependent firms. So the cereal industry consists of four different firms that control almost all of the market. These companies are Kellogg’s, Quaker Oats, Kraft foods and General Mills.
- Oligopoly market as discussed may sell homogenous or differentiated products. The cereal industry sells differentiated products , produced for different categories of population like adults, children ,old age and for health conscious people.
- In an oligopolistic market firms try to make profit in the long run so firms want to enter the market. But there are entry barriers in the oligopoly market. The main entry barrier in cereal industry is the brand loyalty. The companies with more brand loyalty have more market power. For example the cartoon characters companies place on their cereal boxes implant the images in the mind of the consumer and make their brands recognize in the public
- There exists non-price competition in an oligopolistic industry. This means firms do not compete against each other by changing the price of the product but by other mechanisms like advertising, marketing strategies etc. This is also followed by the cereal industry. To increase sales they do not lower or higher price but follow non price means (advertising, product differentiation , marketing strategies and others). For example General Mills advertise their Total cereal with Kellogg’s special K by advertising that Total cereals have more vitamins and minerals and is better than Kellogg’s
Game Theory with profit matrix
Game theory is concerned with the choice of optimal strategy during conflict situations. This theory is also applied in oligopoly market to choose the right course of action for firms. Every game theory model includes players (the decision makers), strategies (the potential choices to change price, advertising campaign etc) and pay-off (the outcomes). The summary of all possible outcomes of various strategies is the pay-off matrix. Games in oligopoly market can be cooperative and non cooperative. In cooperative game two firms will collude to maximise profits. In non-cooperative games firms will set their own price without consulting other firms. The strategy that is optimal no matter what the opponent does is the dominant strategy. Firms also faces prisoner’s dilemma in game theory where the main problem lies among non-colluding oligopolists who maximizes their own profit and can do better by cooperating.
Example
Let us consider there are two major firms of cereal industry Kellogg’s and General Mills. The cost of production for each firm is $1 per unit. Both the firms set their price to $10 and each sells 100 units per week. So they earn a profit of $9,000 a week. If each firm sets the price at $9 and sell $1100 units per week then the profit will be $8,800[($9- $1)*1,100]. But what will happen if one firm charges $10 and other $9. The low price firm increases profits through more sales. The low price firm now sells 1,500 units for a profit of $12,000 while the high price firm sells only $600 units per week for a profit of $5,400. This is shown below in the pay-off matrix.
Profit Matrix
Nash equilibrium is achieved when the firms charge $ 9 per unit. Each firm believes that other firm is going to charge $9 or the best strategy is to charge $9. If Kellogg’s charges $10 then General Mills will charge price at $9 i.e. try to lower price will have a profit of $5,400. Again the same is true for General Mills. In this case the Nash equilibrium is also the dominant strategy. It can be concluded that in Nash equilibrium where each player will be doing as well as it can give the actions of its competitor and so charges the low price.
Non price competition
Economists believe that non price competition is better than price completion as the former is more profitable and desirable in an oligopolistic market. The changes that occur in non price competition are not easily copied by the rival firms as they do in price. Generally the highly concentrated industries face more inelastic demand and normally they rely on non price competition because of relatively high marginal contribution to profits. Non price competition involves mainly advertising and marketing strategies to increase demand and develop brand loyalty among consumers. Some of the policies adopted to increase sales are store loyalty cards, home delivery system, long opening hours, new the techniques for customers, internet shopping etc.
Non Price Competition Strategy
The strategy adopted in the cereal industry is the high degree of product differentiation. In 1950, 26 brands were offered by six firms. The number of brands steadily increased with 28 new brand introductions between 1956 to 1970 so on and more brands till date. The close competition among brands prevents the firms from charging monopoly prices. The high product differentiation is also a strategy adopted by cereal industry. Different products of different companies earn huge profits than the competitors. Like Kellogg’s sale of cereals for kids are high in demand than any other cereal company.
References:
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