Oligopoly Regulation

Have you ever wondered what happens when there are only a few firms in a market, and the government steps in to regulate them? In this article, we'll explore the definition of oligopoly regulation and compare it to monopolistic competition. You'll also discover the various ways governments can regulate monopolies and oligopolies and the advantages and disadvantages of oligopoly regulation. Plus, we'll provide you with real-world examples of oligopoly regulation, so you can see the concepts in action. 

Oligopoly Regulation Oligopoly Regulation

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Table of contents

    Oligopoly Regulation Definition

    Oligopoly regulation definition refers to government regulation to reduce the oligopoly power to ensure appropriate level of competition in the market.

    In microeconomics, we analyze the operations of markets within the broader economy.

    There are four types of markets: perfectly competitive markets, monopolistically competitive markets, oligopolies, and monopolies. These are illustrated in Figure 1 below.

    Oligopoly Regulation Spectrum of market structures StudySmarterFig. 1 - Spectrum of market structures

    A perfectly competitive market features many small firms that are virtually identical and produce virtually identical products.

    Because the products are identical, the price is determined by supply and demand for the entire market.

    A common example is agriculture, where small farms have no control over the market price.

    Monopolistic competition features many small firms that produce differentiated products.

    This gives individual firms some control over their product price, as consumers may have greater demand for some products than others. However, in the long run, price tends to return to market equilibrium as firms can freely enter and exit the market, as with perfect competition.

    Monopolies are single firms that dominate an entire industry.

    Therefore, market supply and demand are the same as supply and demand for the monopoly firm. Price tends to be stable, as new firms often need more time to enter the market due to high barriers to entry.

    For pure monopolies of one single firm, these barriers to entry are often legal, with the government having given a charter to a firm to be the exclusive supplier of some good or service.

    An oligopolistic market features a few large firms that each affect market supply and demand.

    This means that oligopolies are mutually interdependent and must take into account other oligopolists’ business actions. Because oligopolies all have substantial effects on market supply and demand, they are often subject to government regulations.

    Oligopoly regulations are regulations that the government implements to reduce oligopoly power and ensure competition in the markets.

    These regulations are meant to ensure fair competition and maintain market output. This often includes laws to prevent oligopolies from colluding with each other to control larger chunks of market supply, raising prices to make more profit. This is known as antitrust legislation and was originally created to regulate monopolies during the late 1800s.

    Many oligopolies desire to operate in sync to create the effect of a pure monopoly, allowing all participants to make more profit.

    Oligopoly Regulation vs Monopolistic Competition

    The boundary for regulation of oligopoly vs monopolistic competition is determined by the number of firms and their market share (percent of market output generated). This is measured by the Herfindahl Index, which sums the whole squared number of the largest firms’ market shares.

    • The Herfindahl IndexTraditionally, the minimum Herfindahl index value for an oligopoly market would be 1,000, meaning 10 firms that each control 10 percent of the market share. If an 11th firm enters the market, it can be assumed that each firm’s market share is now too small for mutual interdependence to be a necessary consideration. Similarly, a monopolistically competitive market may see firms exit the market, eventually creating an oligopoly where each remaining firm controls a substantial market share.A pure monopoly controls 100 percent of a market and has a Herfindahl index value of 10,000. A duopoly, with two firms each controlling half the market, has an index value of 5,000.

    Both monopolistic competition and oligopoly markets operate similarly when it comes to demand enhancement for their products. Both can advertise to consumers and seek to differentiate their products. However, this only occurs with differentiated oligopolies. These firms produce goods and services that have unique features and brand names, such as automakers and airlines. Standardized oligopolies behave more like monopolies because they produce identical products, such as natural resources like oil and mining. They have high barriers to entry that limit the introduction of new firms into the market, but do not have to brand their products and typically sell them to other large firms.

    Ways Government Can Regulate Monopolies and Oligopolies

    Ways government can regulate monopolies and oligopolies is by antitrust law. To protect consumers, the government creates regulations to prevent monopolies and oligopolies from being anticompetitive or trying to prevent new firms from entering the market.

    Firms can be anticompetitive in a number of ways, such as engaging in predatory pricing to set lower-than-market prices to consumers that new competitors cannot match, creating exclusive arrangements with suppliers, retailers, and regulators, or sabotaging the attempts of new firms to grow and develop.

    The ultimate goal of an unethical oligopolist or monopolist is to engage in price discrimination, where it can charge each consumer the maximum amount that they will pay.

    A price-discriminating monopolist, however, can engage in market segregation to isolate consumers by their willingness to pay.

    By preventing the introduction of competitors, the monopolist or oligopolist (or oligopolists acting in concert like a single monopolist, known as a cartel) can charge the maximum price in each location.

    This causes the marginal revenue curve to merge into the demand curve, as there is no more market price. The MR=MC point of profit-maximization is now D=MC, which is further out from the origin and means the price discriminator is making extra profit. Figure 2 below will help you visualize it.

    Oligopoly Regulation Oligopoly vs monopoly pricing StudySmarterFig. 2 - Oligopoly vs monopoly pricing

    To prevent this, government agencies such as the Federal Trade Commission (FTC) and Consumer Finance Protection Bureau (CFPB) have been created to watch over the markets.

    Consumers and businesses can file complaints about allegedly anticompetitive behavior.

    Regulators also look for price fixing, where oligopolists work together to set higher prices and force all consumers to pay them due to the lack of non-colluding competitors. One regulation that seeks to minimize collusion is a ban on corporate officers owning shares of stock in competitors to reduce the financial incentives to attempt collusion.

    Oligopoly Regulation Advantages and Disadvantages

    There are many advantages and disadvantages of oligopoly regulation.

    An advantage of oligopoly regulation is that it maintains fair competition in markets. Oligopolies that collude and prevent the rise of competitors are likely to restrict output and cause higher prices across the market.

    This harms consumers and also places the market at risk. If an unexpected disaster affects a market that is dominated by colluding oligopolists, there will need to be more output or competition to keep goods and services flowing.

    As a result, the market may face severe shortages. Additionally, collusion allows oligopolists to continue operating without trying to innovate and improve their products. This results in slower economic growth and higher consumer dissatisfaction. A reduction in competition may also eventually put the colluding oligopolists at risk of foreign imports, which will be of higher quality. The domestic market may collapse as consumers switch en masse to imported goods.

    A disadvantage of regulation is that such regulation may be burdensome and force oligopolists to spend lots of money on paperwork.

    For example, large firms may have to hire outside auditors to show that they are not engaging in financial cooperation. Regulations may also dissuade oligopolists from working together on research and development, potentially limiting the size and scope of these projects. Finally, such regulation may be expensive for taxpayers and ineffective, as most oligopolists self-regulate due to the kinked demand curve and price leadership.

    Despite their market power, oligopolists tend to set the lowest possible price due to the risk of price wars. A collusion deal to set higher prices can be broken by any participant, triggering a price war as other oligopolists continually lower their price to win over customers. To avoid this, oligopolists are unlikely to collude: any deal to artificially raise prices could be a trap, and colluders lose customers when they are “tricked” into raising their prices above market equilibrium.

    Oligopoly Regulation Examples

    Let's go over some examples of oligopoly regulation:

    • Sherman Antitrust Act

    • The Federal Trade Commission Act

    • Robinson Patman Act

    The original example of regulation of oligopolists is the Sherman Antitrust Act of 1890. It prevents any “restraint of trade,” and punishes monopolies and oligopolies that intentionally try to prevent the market entry of new rivals.

    The Federal Trade Commission Act goes further and outlaws any deceptive business practices, such as misleading consumers and other businesses in an attempt to limit competition. It could include, for example, making false statements about a rival firm to convince consumers, suppliers, and retailers to do business with it. Next, the Clayton Antitrust Act of 1914 limits mergers of firms to create larger oligopolies or monopolies. Presently, the FTC prevents the mergers of corporations that would allow the combined firm to dominate a market.

    Finally, the Robinson-Patman Act of 1936 bans discriminatory pricing and exclusive deals between firms. This means oligopolies cannot prevent the rise of new competitors by creating exclusive deals with suppliers and retailers. These are sometimes known as tying arrangements and involve bundling goods and services together exclusively, forcing consumers to purchase goods from only one company effectively.

    Oligopoly Regulation - Key takeaways

    • An oligopolistic market features a few large firms that each affect market supply and demand.
    • Oligopoly regulations are regulations that the government implements to reduce oligopoly power and ensure competition in the markets.
    • The boundary for regulation of oligopoly vs monopolistic competition is determined by the number of firms and their market share as measured by the Herfindahl Index.
    • Firms can be anticompetitive in a number of ways, such as engaging in predatory pricing, creating exclusive arrangements with suppliers, retailers, and regulators, or sabotaging the attempts of new firms to grow and develop.
    • To prevent this, government agencies such as the Federal Trade Commission (FTC) and Consumer Finance Protection Bureau (CFPB) have been created to watch over the markets.
    Frequently Asked Questions about Oligopoly Regulation

    How are oligopolies regulated?

    Oligopolies are regulated by antitrust law. Government agencies such as the Federal Trade Commission (FTC) and Consumer Finance Protection Bureau (CFPB) have been created to watch over the markets.

    Is oligopoly regulated by the government?

    Yes, oligopoly is regulated by the government agencies.

    Why do governments regulate oligopoly?

    To protect consumers, the government creates regulations to prevent monopolies and oligopolies from being anticompetitive or trying to prevent new firms from entering the market.

    Who controls oligopoly?

    Oligopolies are controlled by their private owners. However, many oligopolies desire to operate in sync to create the effect of a pure monopoly, allowing all participants to make more profit.

    What are the main features of oligopoly?

    An oligopolistic market features a few large firms that each affect market supply and demand. This means that oligopolies are mutually interdependent and must take into account other oligopolists’ business actions.

    Test your knowledge with multiple choice flashcards

    Is oligopoly regulated by the government?

    The boundary for regulation of oligopoly vs monopolistic competition is determined by the number of firms and their market share as measured by the ____.

    A pure monopoly controls 100 percent of a market and has a Herfindahl index value of ____.

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