The word oligopoly is derived from a word in Greek, ‘oligois’, meaning few and the Latin word ‘polis’ which may mean few (Mandal, 2007). In microeconomics, oligopoly is a term that refers to a situation in which there are few firms in the market.
Owing to the fact that the number of firms is small, there is often a significant degree of interdependence between the firms. This interdependence is seen in the fact that each firm must consider rival firms decisions with regard to price and output policy (Mandal, 2007).
The simplest case of oligopoly is that represented by a duopoly where there are only two sellers. In the case provided the two sellers are the only competitors in their respective business.
Based on the point noted above it is clear that these two have a strong interdependence with respect to prices and outputs. It has been observed that based on their decisions with regard to operation the two could significantly change their profits.
Given that if one cheats and another cooperates, the cheater would earn $1.2 million and the cooperator would earn $200,000 we can assume that this option is unlikely to succeed. If both cheat, they stand to generate $500,000 each and if they cooperate they stand to generate $1 million each. It would appear that the two would opt to cooperate and generate $1 million, with each partner acting as a monopolist in their business.
This position is reached due to the fact that it is not uncommon for oligopolistic firms to reach an understanding that promotes their common interest (Mandal, 2007).
This comes about because of the fact that the primary objective of business which is profit maximization. Due to the presence of a small number of competitors it is likely that through cooperation the two firms will collaborate to create a monopolistic environment.
It has been observed that certain industries operate best as monopolies given that to allow for competition would negate the main economies of scale associated with the nature of such industries (Musgrave & Kacapyr, 2009).
An example of this is seen in plants that generate electricity which require massive generation plants and transmission/distribution networks. Most monopolies are regulated so as to maximize their utility to the consumers.
However, there are instances where a monopoly may operate unregulated. In this case, this monopoly acts with the objective of profit maximization. In such a scenario the organization will determine prices and output at the level of output where Marginal cost is equivalent to marginal revenue (Musgrave & Kacapyr, 2009).
The absence of regulation reduces output and increases product prices. The result is a price that is higher than the competitive price and output which is lower than that of the perfect competitor.
Given the above scenario if a second firm enters the market it is possible to assume that the demand for the product will fall due to the forces of demand and supply. This comes in light of the fact that as supply of a product increases the demand decreases.
In relation to the cost of production it can be assumed that it will also decline. This comes in light of the fact that an unregulated monopolist produces goods at maximum price with minimum cost. Based on this the reduced demand will also reduce production costs.
Mandal, R. (2007). Microeconomic Theory. New Delhi: Atlantic Publishers & Distributors (P) Ltd.
Musgrave, F., & Kacapyr, E. (2009). Barron’s AP Micro/Macroeconomics. Hauppauge, NY: Barron’s Educational Series Inc.