Although oligopoly is sometimes thought of as being on a continuum of market structures (see top of page 636), one could argue that it is a fundamentally different market structure. The reason is that in oligopoly, and in oligopoly only, competitors are mutually interdependent: their decisions on pricing and their level of service depend on what their competitors do. That is, should an oligopolist match or ignore a competitor's price change or change in the level of service? If American Airlines changes its fares, should United Airlines match or ignore the change? If American offers plug-ins for lap-top computers on its flights, should United match or ignore that change in service? Oligopoly could be analogized to a poker game in which the actions of each participant depend on what the other individual competitors are doing. There is room for only so many players around the table. If we had a massive poker table for 1000 players, there is no way each player could react individually to other participants' actions. Similarly, in oligopoly, the number of significant competitors must be small enough so that each company can take into account and react to decisions made by other companies. An oligopoly may consist of dozens of companies, but if only a few companies dominate the market and are interdependent, then the market structure is oligopoly.

Let's consider some examples of different types of oligopolies. One form of oligopoly is known as a duopoly, a market dominated by two major competitors, such as Coca-Cola and Pepsi. Coca-Cola has nearly a 50% market share and Pepsi has close to 40%. Other competitors, such as Royal Crown Cola and various local brands, share the remainder of the market. It is self-evident that Coke and Pepsi keep an extremely close watch on each other and are constantly deciding how to respond to the other's pricing decisions. They also must decide what to do if the other introduces, say, a new type of diet soft drink. If Pepsi introduces a new diet drink with one calorie that is tastier than its traditional diet Pepsi, should Coke do the same or ignore it?

As mentioned earlier, another example of an oligopoly is the airline industry. It is dominated by the "Big Three", American, United, and Delta, each having a market share of roughly 20%. There are other significant players such as Southwest, Northwest and Continental. Consider the following data:

To measure the market power in the industry, we can calculate Concentration Ratios for the top four and top eight firms in an industry. In some oligopolies, only the top four concentration ratio would be relevant. The concentration ratio for the top four firms in this industry = 70 ( 21 + 19 + 18 + 12). This may be abbreviated to: CR4 = 70. The CR4 in an oligopolistic market structure would typically be at least 40 to 50. The concentration ratio for the top eight firms in this industry (CR8) = 99. These ratios indicate that this industry is quite concentrated, that is, there is a lot of market power, particularly in the hands of the top three firms. Without question, each airline must respond (either match or ignore) to fare changes or service changes offered by other specific airlines.

Another numerical approach to measuring market power is to square the market share held by each firm and then add these squares. This is known as the Herfindahl index. Consider this table:

The Herfindahl index (HI), not surprisingly, shows an industry with considerable market power. We would expect an oligopolistic industry to have an HI of at least 800 to 1000, although such an HI would indicate a weak oligopoly.

Compare the HI for the airline industry to the HI for the soft drink industry. For Coca-Cola, we have roughly 50 x 50 = 2500; for Pepsi, we have 40 x 40 = 1600. The HI = 2500 + 1600 or 4100. Other market shares, such as the share held by RC, don't have a significant impact on the HI. You can tell that the HI gives a lot of extra value to high market share by squaring them. We know that the HI of 4100 for the soft drink industry indicates a lot more market power than the HI of 1489 in the airline industry, even though the airline business itself is a strong oligopoly.

Note that concentration ratios would not be as effective in showing this, especially with the duopoly in soft drinks.

Here is an example of a weaker oligopoly. (Some might argue that it is an example of monopolistic competition, but that doesn't seem right, for reasons that follow.)

What is the CR8? 81 (17 + 15 + 11 + 11 + 9 + 9 + 7 + 2)

Although weaker, this is still oligopoly due to the mutual interdependence. Are the competitors, in effect, sitting around the poker table, matching or ignoring what their competitors are doing on an individual basis? Yes. If Beretta introduces a new safety lock on its pistols, clearly the others must decide whether to develop a similar safety device or not. If Smith & Wesson slashes its handgun prices by 15% on a permanent basis, the other participants must decide whether to match the individual action taken by Smith & Wesson.

This characteristic of mutual interdependence is not true in other market structures. By definition, a monopolist that supplies all or almost all of a product for which there are no close substitutes, has no competitors. In perfect competition, the product is identical and all participants are small enough so that no one has any market power. That is, no firm in perfect competition has enough market share to individually influence the price of the product through its own supply decisions. Each firm is a pure price taker.

There is no mutual interdependence. The market as a whole, that is, the interaction of market demand and supply curves, determines product price. For the market structure of monopolistic competition, which will be discussed more fully in a moment, the idea is that there are too many competitors for a firm to react to on an individual basis.

A few more comments about oligopoly: In your text, there is discussion of concentration ratios and the Herfindahl index on pp. 638-639.

Colander discusses the Cartel Model on page 646. As an example of this, consider the Organization of Petroleum Exporting Countries (OPEC). Each of the twelve members has an assigned production quota. The effect is to restrict supply (i.e., shift the supply curve to the left) and thereby boost the price. As you would suspect, such explicit collusion would be illegal under United States anti-trust laws.

Speaking of collusion, we can find examples of implicit price collusion in the U.S. economy. In some oligopolies, there is a price leader who typically raises prices first. The other competitors then more or less follow the leader. For example, General motors might announce a 3% price increase for the new model year and shortly thereafter, Ford announces a 2.5% increase. On the other hand, some oligopolies don't seem to have a clear price leader. For instance, in the airline industry, different firms raise or lower their fares at different times. The others then decide to match or ignore. There is no specific airline that always goes first on fare changes.

Notice the author's discussion of the kinked demand curve and sticky prices on pp. 647-648. This describes the behavior of prices in some oligopolistic industries, but not all. A starting market price is given. The idea is that firms will match any price cuts made by their competitors to make sure they don't lose any market share. This means that a firm that cuts prices will obtain very little increase in sales because other firms will match the cuts. So for prices below the starting market price, demand is inelastic and the demand curve has a steep slope.

The other half of the kinked demand curve theory is that firms will ignore price increases made by competitors. If this is true, then an oligopolist that raises price will find that its sales level will drop substantially as other firms leave their prices unchanged.

This is the elastic portion of the demand curve. You'll notice that this section of the demand curve has a flatter slope to it. So the kinked demand curve has two sections. The top portion is shallow and elastic; the bottom section is steep and inelastic.

Colander's discussion of monopolistic competition begins on page 640.

This market structure has product differentiation, as is true in some oligopolistic markets (e.g., automobiles), but not all (e.g., steel). Monopolistic competition is associated more with small business operations such as a sole proprietorship or a family-owned business. Monopolistic competition could be labeled fragmented competition or modified pure competition. The idea is that there are so many other competitors that it is not possible to react on an individual basis to what other firms are doing with prices and associated services. Of course, any business must be generally competitive or it won't stay open for very long.

An example of a monopolistically competitive market is flea market dealers. There may be dozens or even hundreds of dealers at a particular flea market. They sell similar but not identical products. Since the products are not identical, the dealers have some discretion on pricing, that is, they are not pure price takers as are competitors in the perfect competition market structure. But there are so many dealers that it is not possible to keep track of and react to price changes made by other dealers.

Another example of monopolistic competition is hair stylists. This market consists of many firms that do their styling work at business establishments and many others who work out of their homes. There are so many stylists that there is no way they can keep track of what every other hairdresser is charging and react to that on an individual firm basis. Since the skill level and specific services offered vary from stylist to another, each business has some discretion on pricing and is not a pure price taker. To the extent a stylist can build a clientele through skillful and artistic work, the stylist has a small amount of market (or monopoly) power.

Monopolistic competition is a market structure that can be troublesome in its application. For instance, I have seen the convenience store industry described as monopolistically competitive, but, at least in the Tulsa area, that is clearly not so. Without question, the industry is oligopolistic and is led by Quik-Trip.

A related industry, the grocery store business, was described in another book as monopolistically competitive and the relevant market was defined as statewide. But we don't do our grocery shopping on a statewide basis. If we live in or near a city, then the relevant market may be stores located within five to ten miles of our homes. The market structure is oligopoly. What is the market share held by the top four grocery stores in your area? Is it 40% or more? Almost certainly it is. Is there mutual interdependence? Yes. Stores often send employees to their competitors' stores to check prices and other services offered by the competition. Grocery stores do react on an individual firm basis to what various competitors are doing.

I have even seen the airline industry described as an example of monopolistic competition. But this is nonsense. Without a doubt, the correct classification is oligopoly.

One could take the position that the flea market dealers discussed above should be subdivided into more specific markets. For instance, dealers who sell antique cameras and other photographic collectibles are in direct competition with other camera dealers, not with vintage clothing dealers. These camera dealers may very well react to what other dealers do on an individual firm basis, making this a sort of "mini" oligopoly.

Men's and women's clothing stores have also been described as monopolistically competitive. But consider a large shopping mall with several clothing stores. Perhaps they do in fact respond to price and service changes on an individual firm basis. That is, the clothing stores in a mall constitute another mini-oligopoly.

Even the author, who does an excellent job in dealing with monopolistic competition, has some questionable examples. Look at the top of page 645 and you'll notice Cheerios. But who makes all of the cereals we buy at the grocery store? Kellogg, Post, General Mills... it is a market dominated by several large players with high concentration ratios and a high Herfindahl Index. There are local house brands of various cereals, but they are not the dominant players in the cereal industry.

The other examples (watches and bleach) are also oligopoly, not monopolistic competition. The difficulty is not so much with the description of monopolistic competition as it is with the application of the model. Many of the suggested examples will fit better into some form of oligopoly.