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Chapter 9
Oligopoly
Concentration and Prices Concentration is an important factor affecting pricing and profitability within markets. Other things being equal, increases in concentration can be expected to be associated with increased prices and profits. One way to make this point is to appeal to the extreme cases of pure competition and pure monopoly. Under pure competition, market price equals average cost, leaving all firms zero economic profits (i.e., normal rates of return). Low concentration leads to minimum prices and zero profits. Under a pure monopoly, in contrast, a single dominant firm earns maximum excess profit by optimally raising the market price. Given these polar results, it is natural to hypothesize a positive relationship between an industry’s degree of monopoly (as measured by concentration) and industry prices. For instance, the smaller the number of firms that dominate a market (the tighter the oligopoly), the greater is the likelihood that firms will avoid cutthroat competition and succeed in maintaining high prices. High prices may be a result of tacit collusion among a small number of equally matched firms. But even without any form of collusion, fewer competitors can lead to higher prices. The models of price leadership and quantity competition (analyzed in the next section) make exactly this point. There is considerable evidence that increases in concentration promote higher prices. The customary approach in this research is to focus on particular markets and collect data on price (the dependent variable) and costs, demand conditions, and concentration (the explanatory variables). Price is viewed in the functional form P f(C, D, SC), where C denotes a measure of cost, D a measure of demand, and SC seller concentration. Based on these data, regression techniques are used to estimate this price relationship in the form of an equation. Of particular interest is the separate influence of concentration on price, other things (costs and demand) being equal. The positive association between concentration and price has been confirmed for a wide variety of products, services, and markets—from retail grocery chains to air travel on intercity routes; from cement production to television advertising; from auctions of oil leases and timber rights to interest rates offered by commercial banks. More generally, a large-scale study of manufacturing (using five-digit product categories) for the 1960s and 1970s shows that concentration has an important effect on
