What is Oligopoly?
An oligopoly arises out of a market which is dominated by a little figure of Sellerss, besides known as oligopolists. The oligopolists dominate a significant part of the market and are known to be reciprocally dependent. The common dependence is determined by the ability of one marketer to act upon the determination of the others in the market ( Begg and Ward 2009 ) .
Bhagwati ( 1970 ) clarifies that traditional oligopoly theory was derived the premise – each house maximizes net incomes and each house concerns with the reverberations of its action on the challengers. The latter premise distinguishes oligopoly from competitory theories. Absolutely competitory construction assumes ‘a cut in monetary value enables higher gross revenues and raise in monetary values decline gross revenues ‘ , whereas an oligopolistic house is witting of the impact of its determinations on the economic behavior of the challengers ( Bhagwati 1970 ) .
Each house besides believes that a monetary value rise will non be followed by challengers but a monetary value cut would be. This is represented in the “ Kinked Demand curve ” developed by Sweezy ( Riley 2006 ) .
Beginning: Adapted from tutor2u.net ( 2010 )
Common illustrations of oligopolistic industries are oil, banking, retail ( food market, vesture ) , music etc.
Main economic characteristics of an oligopoly:
An oligopoly is characterised by factors such as barriers to entry, merchandise distinction, mutualist determination devising, competition and collusion etc.
Barriers to entry:
Stigler ( 1965 ) , defines barriers to entry as “ a cost of bring forthing ( at some or every rate of end product ) which must be borne by a house which seeks to come in an industry but is non borne by houses already in the industry ” . Barriers may originate out of natural causes such as factors outside the control of an entrant or by strategic causes created by officeholders.
A primary barrier to entry is economic systems of graduated table. In the long tally, Minimum Efficient Scale ( MES ) is the point of efficiency where a house produces the needed degree of end product to run into the demand, at an mean cost. As shown in the diagram below, it takes a larger works to achieve MES at a certain cost and a smaller works will non be able to bring forth at MES. The costs of production will lift ( Begg and Ward 2009 ) .
Beginning: Begg and Ward ( 2009 )
Stigmatization may forestall new entrants when the MES is low plenty to pull new participants. When an incumbent spends more on merchandise stigmatization and advertisement, its long tally production costs are higher, therefore the MES is shifted towards greater measures of end product. This in bend affects new entrants ( Begg and Ward 2009 ) .
Sunk costs besides deter entry/exit and the market appears non contestable. Sunk costs are immense costs invested into the concern, which can non be regained on issue ( Begg and Ward 2009 ) , such as on trade name development or immense equipments which are scrapped on issue. An entrant may disregard the pre-entry monetary value and net income degrees with barriers to entry, but will deduce the post-entry equilibrium monetary value and net income degrees. Salop ( 1979 ) states that the officeholder may discourage the every bit efficient entrant by exposing sunk costs, which make his ain issue wasteful.
Therefore, if expected net incomes are negative, the entrant is deterred and the no-entry net incomes accrue to the officeholder.
Key economic theories of monetary value repair:
The oligopolist will take at repairing a monetary value which promises maximal net incomes or screens expected costs and ensuing in sustainability in the long tally ( Rothschild 1947 ) . Therefore the waies that industries take in an oligopolistic state of affairs would be to either compete or collude with other houses.
Fierce competition reduces industry net incomes. Firms use schemes such as take downing monetary values or increased advertizements to catch market portion. This is a loss to the houses and a addition to consumers.
A Cartel occurs when houses get into a formal conniving understanding to portion net incomes and keep important market portions and hence set the monetary values at the net income maximization degree ( Sloman et al 2010 ) . Trusts are formed for the common benefit of members. The industry net incomes are maximized and consumers are at loss. This is because the trust may ensue in higher monetary values or monopoly markets.
For case, Nokyo is a Nipponese agricultural trust, commanding the rice trade. Nokyo ‘s umbrella laterality included Zenno, the concern arm commanding important per centums over fertilisers, agrichemicals, and rural crude oil, provender and farm markets.
For case, in selling 60kgs of semi-controlled rice for A?21000, tax write-offs will consist of managing charge of 2.0 per centum at the local Nokyo subdivision, managing fee of 0.6 per centum charged by the Keizairen [ Nokyo ‘s prefectural association ] , and Zenno ‘s managing fee of 0.4 % all borne by the husbandman and included in the consumer ‘s monetary value. The trust is permitted and supervised by the Government ( Bullock 1997 ) .
Non-price competition occurs when the trust participants try alternate ways of viing against one another such as merchandise distinction, where the house tries to maximise net incomes with a alone merchandise or zone based monopolies where each house covers different parts to maximise gross revenues.
Tacit collusion occurs where there is a market leader and other houses in the oligopoly follow the leader ‘s pricing statements. The market leader is an constituted house with greater influences over monetary values.
Game Theory is a decision-making procedure where one participant ‘s pick must impact the involvements of other participants. The final payment is the accumulated consequence on the pick made ( Begg and Ward 2009 ) .
In the tabular array below, the game would be publicizing quandary for Sony and EMI. The determination is a pick between publicizing to a great extent and reasonably and the wage offs are listed.
The dominant scheme is to take the determination which consequences in best possible result, whereby EMI would take cell B and Sony would take cell C.
Nash equilibrium is the pick of optimum determination when the opposition ‘s behavior is known or is trusted. Here EMI would take to chair if it knew Sony would reasonably publicize and therefore choice cell D and there is no inducement to travel from this place.
Maximin is picking the least bad among the worst determinations when the opposition behavior is favorable, in which instance, EMI and Sony choses A. Maximax is picking the best possible result when opposition is non favorable, which is B for EMI and C for Sony.
It is evident in this instance that the dominant scheme is besides Maximax. Therefore, the dominant scheme is the best scheme for the house.
Oligopoly in the Music Industry
Let us see the music industry. The music industry is an oligopoly, with the “ Large Four ” accounting for 71.7 % of the universe market portion for retail music ingestion.
By using the N-firm concentration ratio, which is a step of the entire market portion attributed to the N largest houses, the music industry is therefore an oligopoly with 4 houses keeping market portion between 50 % -80 % , and hence, average degree of concentration ( AmosWEB 2010 ) .
What are the barriers to entry in the music industry?
Cost barriers: Natural Barrier
Caves ( Lewis et al 2005 ) stated that hazard is high where 10 % of merchandises account for 90 % of turnover and cipher knows the grounds for success.
Therefore, when record companies buy major creative persons, they bear the fiscal hazard with 90 % of the creative persons that are non successful. Success of creative persons has a direct impact over the grosss generated and it is seen that 20 % of the grosss are re-invested in Artists and Repertoire ( A & A ; R ) ( BPI 2009 ) which oversees development of new creative persons.
Major costs are besides observed in marketing the music with six figure dollar investings.
For case, Ged Doherty of Sony BMG estimates it costs more than ?1m to interrupt a dad act and over ?700,000 to interrupt a stone act in the UK entirely ( IFPI 2010 ) . Established creative persons ‘ progresss go every bit high as US $ 1.5m.
High creative person development costs hence remain a changeless barrier. Firms will besides hold to keep successful coaction with bigger creative persons which generates figured bass grosss for new creative persons.
Price-fixing in the Music Industry
Firms are mostly affected by menaces of buccaneering, free music exchanges over the Internet, low-priced retail monetary values etc. and hence, they resort to common patterns of price-fixing to keep competitory advantage and net income maximization.
Minimum Advertised Price ( MAP ) : Strategic Barrier
Minimum Advertised Pricing is a provider ‘s pricing policy that does non allow resellers to publicize monetary values below a specified sum. It can include the resellers ‘ retail monetary value every bit good.
In August 2000, Vivendi, Sony, Berteslmann, Warner and EMI Group ( henceforth called “ Large Five ” ) along with three retail merchants Musicland Stores, Trans World Entertainment and Tower Records were accused of utilizing MAP ( BBC News 2002 ) .
A 2nd instance in 2008 involved Starr et Al v. Sony BMG Music Entertainment et Al. Monetary values were fixed by making joint ventures for administering vocals through MusicNet, launched by BMG, EMI and Warner Music and Pressplay, launched by Sony and Vivendi ‘s Universal Music Group and through restrictive licence understandings. The sweeping monetary value was “ an in agreement sweeping monetary value floor ” of 70 cents per vocal. The instance was filed on behalf of people who download vocals over the Internet ( Reuters 2010 ) .
Hence, MAP is an advantage to providers since it prevents price reduction challengers making a barrier for entrants. It besides enables retail merchants to reimburse selling costs for new merchandises since makers agree to supply advertisement subsidies which enables perpendicular integrating for growing.
Game Theory: Revisited
When Napster entered the peer-to-peer music file sharing market over the Internet, it carried a strong entreaty. The Big Five filed a suit against Napster in December 1999, claiming that the “ free service ” cut into CD gross revenues.
Revisiting the game theory discussed above, allow us see schemes that Bertelsmann and the Big Five ( excepting Berteslmann ) would use. When the Big Five agrees to extinguish Napster, but Berteslmann darnels on the understanding and merges with Napster, it is a Maximax and dominant scheme for Bertelsmann. If the Big Five ( excepting Berteslmann ) decide to unify and rip off Bertelsmann, it is a Maximax for the Big Five ( excepting Berteslmann ) .
At this phase, Bertelsmann broke ranks with the Big Five and cheated over the oligopoly to unify with Napster. It announced to loan Napster $ 50 million ( ?31 million ) to develop a file sharing system and to retain 58 % involvement in Napster when the service was developed ( McCourt and Burkart 2003 ) .
It was therefore observed that the music industry is an oligopoly which holds market laterality and prevents new entrants with important entry barriers. It is apparent that the industry oligopolists employ price-fixing schemes for net income maximization and other competitory advantages. The extent to which record companies continue to retain this laterality will be determined by the continued challenges faced by the officeholders and the possible entrants.