SummaryThe analysis of market structures is of great importance when studying microeconomics. How the market will behave, depending on the number of buyers or sellers, its dimensions, the existence of entry and exit barriers, etc. will determine how an equilibrium is reached. Even though market structures were thoroughly analysed by economists from the early 20th century on, its study can be traced back to economists such as Antoine Cournot, Alfred Marshall or even Adam Smith.
Oligopoly (from the Greek «oligos», few, and «polein», to sell) is a form of market structure that is considered as half way between two extremes: perfect competition and monopolies. This kind of imperfect competition is characterized by having a relatively scarce amount of firms, but always more than one, which produce a homogeneous good. Due to the small number of firms in the market, the strategies between firms will be interdependent, thus implying that the profits of an oligopolistic firm will highly depend on their competitors’ actions.
Firms in oligopolistic market can have a wide range of behaviour patterns making it difficult to have a single model. Static models are used as they present a simple way of analysing equilibriums in this market. However, the maximisation problem faced by the firm will be marked by the different strategic interdependence context in which that market works. Therefore, the firm must estimate and collect the reactions of its competitors in its optimisation problem to choose the best strategy to follow. As a result we must propose a conjectural variation on how competitors modify their behaviour as the firm varies strategies.
Let’s see how conjectural variation affects each firm’s behaviour and final output. We start with the profit (πi) maximisation problem, where Q is total output, q corresponds to each firm’s output and C is its production costs:
Setting this to zero for maximisation, we have:
Therefore, rearranging the previous function we have:
From this last function, we can assume the following:
-each firm’s profits are directly related to its competitors’ behaviour, which determines the conjectural variation (CV).
-each firm’s behaviour depends on the conjectural variation of their competitors: if CV>0, the firm will react by striking back with the same action (lowering prices, for example); if CV<0, the firm will choose the opposite strategy; if CV=0, the firm will accommodate its competitor’s strategy, as the Cournot duopoly model assumes.
-each firm’s behaviour, understood as reactions to each other’s strategies, define the market structure and the degree of competition.
For simplicity purposes, oligopolies are specially studied in cases in which there are only two competitors in the market. These are known as duopolies and its analysis and conclusions can be extrapolated for oligopolies.