Chapter 12: Problem 1

What are the causes of oligopoly? Discuss.

Short Answer

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Answer: The main causes of oligopoly are high barriers to entry, economies of scale, mergers and acquisitions, control over a unique or scarce resource, and strong brand loyalty. These factors contribute to a market structure where only a few large companies control the bulk of the market, leading to the strategic interdependence of firms and potential for non-competitive behavior.

Step by step solution

Definition of Oligopoly

An oligopoly is a market structure characterized by a small number of large firms that dominate the market, producing similar goods or services, thus having significant control over prices. In this situation, these firms are interdependent and can often engage in non-competitive behavior, such as price-setting or collusion.

Barriers to Entry

One of the primary causes of oligopoly is the presence of high barriers to entry in the industry. These barriers could be in the form of high initial capital investment, strict government regulations, high research and development costs, or control over essential resources. As a result, new firms find it difficult to enter the market and compete, leading to a smaller number of dominant firms.

Economies of Scale

Another cause of oligopoly is the existence of economies of scale. In certain industries, the cost per unit of a product or service decreases as the level of production increases. Consequently, larger firms, which can produce more significant quantities at lower average costs, are more likely to dominate the market. Smaller firms, unable to achieve similar economies of scale, struggle to compete with these larger firms.

Mergers and Acquisitions

Oligopolies can also be a result of mergers and acquisitions (M&A). As firms consolidate through M&A, there will be an increased market concentration, leaving a smaller number of powerful firms dominating the market. M&A can happen due to strategic reasons, market conditions, or regulatory approvals and can lead to oligopolistic market structures.

Control Over a Unique or Scarce Resource

In some instances, a few companies control a unique or scarce resource essential to a particular industry. This control allows them to effectively restrict access to the resource and limit the number of competitors that can enter the market. As a result, the market will become concentrated, leading to an oligopoly.

Brand Loyalty

Strong brand allegiance can also contribute to the formation of an oligopoly. If consumers are fiercely loyal to certain brands, it can be challenging for new firms to enter the market and convince customers to switch products. In such cases, the market will continue to be dominated by a few well-established firms.

Conclusion

In summary, the main causes of oligopoly are high barriers to entry, economies of scale, mergers and acquisitions, control over a unique or scarce resource, and strong brand loyalty. These factors contribute to a market structure where only a few large companies control the bulk of the market, leading to the strategic interdependence of firms and potential for non-competitive behavior.

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