11
Oligopoly: Firms in Less Competitive
Markets
Chapter Summary
An oligopoly is a market structure in which a small number of interdependent firms compete. Barriers to entry make it difficult for new firms to enter an oligopoly industry. Three barriers to entry are economies of scale, ownership of a key input and government-imposed barriers. To analyse oligopolies, economists use game theory, which is the study of how people make decisions in situations where attaining their goals depends on their interactions with others. In oligopolies, interactions among firms are crucial in determining profitability because all firms are large relative to the market.
Michael Porter developed a model showing how five competitive forces determine the overall level of competition in an industry. These forces are: (1) competition from existing firms, (2) the threat from potential entrants, (3) competition from substitute goods or services, (4) the bargaining power of buyers, and (5) the bargaining power of suppliers.
Learning Objectives
When you finish this chapter you should be able to:
1.Show how barriers to entry explain the existence of oligopolies. Barriers to entry make it
difficult for new firms to enter an oligopoly market. The most important entry barrier is economies of scale. The greater the economies of scale, the fewer the number of firms in the industry.
Another entry barrier is ownership of a key input. If production of a good requires a certain input, control over the supply of that input will be a barrier to entry. Government imposed barriers, such as patents, occupational licensing or import restrictions (tariffs or quotas) may also limit entry of new firms.
e game theory to analyse the actions of oligopolistic firms. In oligopolies, the interaction of
firms is crucial in determining profitability because firms are large relative to the market.
Economists use game theory to predict the decisions of firms when their goals depend on interactions with other firms.
e sequential games to analyse business strategies. Economists use sequential games to predict
and explain the behaviour of firms in business situations where the actions of one firm will lead to
a response from another firm. Sequential games are used to analyse deterring entry and bargaining
between firms.
e the five competitive forces model to analyse competition in an industry. Michael Porter
developed a model showing how five forces determine the overall level of competition in an
