This model is a very interesting one. It explains some phenomena that are happening in oligopolistic type markets. So what does it means? Price leadership is an implicit (invisible) agreement among oligopolists by which they can coordinate prices without involving in price collusion based on secret meeting or formal agreements. This kind of method requires the “dominant firm” (largest or most efficient one) to initiate price changes, so that all other firms more or less will try to follow this leader. In many industries cement, fertilizers, cigarettes, cars and diverse machineries industries practiced this price leadership.
Price leadership in industries suggests that the price leader may use some of the following tactics:
Price changes (infrequent)
Since the price change may create the risk that the rivals won’t follow it, price regulations should be made only infrequently. Price leader shouldn’t respond to daily small increases in costs and demand. Price should be modified just in the case when costs and demand have changed greatly, for example the price of row materials or wages of workers increased rapidly, or government excised higher taxes.
Price leader sometimes communicates higher costs other oligopolistic firms by means of speeches of major executives or press. By publicizing the need to raise the price, price leader seeks other rivals to inform and to agree about price modifications.
Price leader may not always choose the price that maximizes the profits in short-run for the industry, because it wants to block the entry to this industry of new firms. If economies of scale of existing firms are the major barrier, then new firms can pass this obstacle if the existing firms, including price leader, set a high-price for the goods and services they produce. So, new small firms may survive only if the industry sets a very high price. To block the entry of new firms to this oligopolistic market system, this price leader may keep the price bellow short-run maximizing level. This strategy of blocking entry from the new firms is called limit pricing.
Sometime price leadership in oligopolistic market system may end up at least temporarily or may result in price wars. Most price wars sometimes run their course. When the firms realize that low prices are reducing their revenues dramatically, they may “offer” price leadership to other industry’ leading firms. That firms starts to rise prices and other businesses are willing to follow.
In economics technological advantage is new and better goods and services and new and better ways of producing or spreading them. This process occurs over a theoretical time called very long run, than can be as short as few weeks or as long as many years. Let’s recall that in all our market systems (pure competition, monopolistic competition, oligopoly and pure monopoly), the short run is a period in which technology, plant are fixed, however in the long run , technology is constant but the firms can change their plant size and are free to enter and exit the industry. In contrast, very long run is a period in which technology can change and firm can develop and supply totally new products.
It’s known that technological advantage shifts product possibility curve upward, enabling economy to achieve more goods and more services. Technological advantage can be is made up of three parts: invention, innovation, and diffusion.
The first step to technological advantage is invention: the discovery of product or process of producing by using imagination, thinking and experimenting. Invention is a process and the result of it is also called invention. Invention is based in scientific knowledge and it is the result of work of individuals who work on their own or as members of Research and Development (R&D) departments in firms. Government encourages invention by providing patents, right to sell any innovative process of production, machines or products in a set time.
Innovation is directly related to invention. While invention is “discovery and proof of workability”, innovation is the successful introduction of new product (invention) in the market, the first use of a new method of producing, or the creation of new form of business firm. There are two types of innovation: product innovation, improving products and services, and process innovation, which is improved ways of production and spreading of these inventions in the market.
In contrast to invention, innovations cannot be patented. Innovation needs not to weaken or destroy the existing firms. Because new products and processes threaten firms’ survival, existing firms have a high incentive to engage into research and development (R&D) process continuously. These innovative products and processes enable firm to earn higher revenue or to maintain the present ones. Innovation can strengthen or weaken market power.
Diffusion is the process of spreading of inventions through imitating or copying. To take the advantage of new profits or to slow down disappearing of others, all firms try to implement the innovations. In most of the cases innovation leads to widespread imitation (that’s diffusion) of inventions. For example, soon after McDonald’s introduced the fast-food hamburger, Burger Kings also started to produce it, since it offered high revenues for the firms that supplied this good.
Research and Development (R&D) Expenditures
When it’s related to business research and development means the efforts towards inventions, innovations and diffusion. Many countries engage in R&D of national defense, so that annually they spend thousands of billions of dollars.
Importance of Technological Advantage
Technological advances for many centuries were viewed ad external to economies, like a force to which economies adjust. Periodically new advances in scientific and technological knowledge occurred. Firms and industries, incorporated new technology into their products and production process to increase or to maintain their revenues. After making some adjustments, they continue to settle into long-run equilibrium position. Economists believe that technological advantage is related to advance of science, which is very important for market system. Some of economists see capitalism is the as driving force of technological advantage. Technological advantage arises from rivalry among individuals and firms that motivates them to seek and exploit new opportunities of profit and of expanding. This rivalry occurs between new firms and existing ones. Entrepreneurs and innovators are viewed as heart of technological advantage.
Oligopoly is a market system that is dominated by few big suppliers of homogeneous or differentiated products. Because there are few firms, oligopolists have great control over prices, but they should consider reaction of rivals after they change price of goods, output quantity and amount of money spent on advertising.
The phrase “few large producers” is one necessary to describe this kind of market system. Some examples of oligopoly can be two or three zinc producers in Sweden, or five or six producers of auto parts in U.K. When you will read in some magazines at economics about Big Three, Big Four or Big Five, you may be sure that there is described an oligopoly.
Homogeneous or Differentiated Products
An oligopoly may be either homogeneous or differentiated one, since the firms in this kind of market system produce a standardized or differentiated product. Many industrial goods( aluminum, lead, cement) are standardized products that are supplied in oligopolies. However, other goods (like cigarettes, automobiles, breakfast cereals) are produced in differentiated oligopolies. Last kind of oligopoly engages in non-price competition by heavy advertising.
Price and mutual interdependence
Since in oligopolies there are few firms, each one is a price-maker, like monopolists the y may set the price and output level for their goods, so that these firms control the revenue. However, unlike monopolists (since there are no competitors), oligopolists should consider the reaction of rivals to this changes in price, output, product’s characteristics and money spent on advertising. Thus Oligopolists are described by mutual interdependence: a situation in which firm’s profits doesn’t depend completely on its price and sales policy, but also on that of rivals. For example, before increasing the price of its drinks Pepsi should predict the response of other major producers, like Coca-Cola.
Similar entry barriers created in pure monopoly are also created in oligopoly. Economies of scale are a factor that serves as barrier to entry in some oligopolistic industries, such as aircraft, car-producing, and cement industries. In this kind of industries three or four firms control the market supply, so that they have enough money to produce economies of scale, but other firms even if they will want to enter this market will have a small market share so that they won’t be able to have enough revenues to produce economies of scale. They would be high-cost producers, so that these firms won’t be able to survive in this industry.
Ownership and control of raw materials are another explanation why it’s very difficult to enter in oligopolistic market system. Oligopolists also prevent the entry of new competitors by preemptive pricing and advertising strategies.
Some oligopolies have started because of very fast growth of dominant firms in some industries. But other however, produced an oligopoly by merging with other competing firms. Merging or combination of two or more firms may increase their revenues and economies of scale, because of increased market share they got.
Another explanation of “urge to merge” is the want for a higher monopolistic power, since larger firm has a greater control over market supply and on the price of its product. Also, because of higher economies of scale they get less costs on producing some goods and services than their rivals.
Is merge between Google and Facebook possible and also profitable?
There are four models of market system: pure competition, pure monopoly, oligopoly, monopolistic competition.
Let’s describe them briefly:
- Pure competition- is a market structure that is composed of a very big number of firms that produce a standardized product. Entry and exit from this type of market is very easy.
- Pure monopoly- is a market structure in which one firm (or a very few ones) is single seller of a product or service. Entry to this kind of market system is blocked, so one firm can rule the entire industry. Monopolists produce unique product and there is not any reason to difference it, since there are not competitors.
- Monopolistic Competition-is characterized by relatively large number of suppliers who produce differentiated products. There is nonprice competition (each firm is trying to distinguish its product or service by some characteristics like quality, price). Entry to monopolistically competitive industry is relatively easy.
- Oligopoly- is made up of sellers with identical or similar products so that the change in price of one may affect future decisions of other firms.
Pure monopoly, oligopoly and monopolistic competition are considered as imperfect competition.