Economic Analysis of the Cell Phone Oligopoly

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Table of Contents

Abstract
Oligopoly competition
Oligopoly price determination
Demand elasticity in oligopolistic markets
Game theory in oligopolistic markets
Profit maximization in oligopolistic structures
Oligopolistic markets benefits and disadvantages
References

Abstract

An oligopoly is a market type in which an industry is controlled by a small number of sellers / firms and their products are either homogeneous or are differentiated (Riley, 2006). Market participants usually predict the actions of the competitor. Cell phone industry is a good example of an oligopolistic market structures since the number of organizations serving the industry is small.

The industry is dominated by organizations such as Nextel/Sprint and Verizon among others. Existence of oligopolistic markets structures exists in markets where there are large initial capital requirements, scarcity of growth opportunities and due to government regulations.

The paper will focus on the nature of oligopoly market in cell phone industry. Essentially, it brings forth how firms in the industry compete, how prices are determined, effects of demand elasticity on competition, and the application of the game theory. In addition, the essay discusses the equilibrium point of maximizing profits, advantages and disadvantages of the market structure.

Oligopoly competition

Oligopoly market structures are characterized by few large suppliers, the products are differentiated or homogeneous and the firm in the industry is driven by self-interest to set prices and output levels to maximize profits. Cell phone industry is of kind where products offered by the players are homogeneous and the competition is judged by the price determination.

According to Thomas & Charles (2007), the decisions of one company influence the decisions of competitors and also decisions of competitors influence decisions of a company. Generally competition in the industry takes three forms. These are;

Free competition and one company become a price leader
Larger firms becomes price setters and /leaders while smaller ones become the price-taker.
Cartel system exists where firms collude to agree on prices to surpass stiff competition.

Generally, the ability of the firm to dominate the market and have probability of control is determined by the economies of scale. This implies that organizations that take advantage of economies of scale in the oligopolistic markets will set lower prices and produce larger quantities becoming cost and price leaders (Thomas & Charles, 2007).

Conversely, two or more firms in the industry might collude to lessen the level of competition by forming cartels. In this case, small firms will be denied entry and if exist remain as price takers. Typical case in the cell industry is where dominant firm such as Verizon takes lead in making prices and impacts the price decisions on the small firms thus becoming price leader.

Oligopoly price determination

If an industry is composed of few cell phone firms each selling identical or homogenous products and having powerful influence on the total market, the price and output program of each is likely to affect the other significantly. This will consequently promote collusion ending to industry cartels.

In case there is product differentiation, an oligopolistic firm can raise or lower prices without any fear of losing customers or immediate reactions from his rivals (Thomas & Charles, 2007). However, intense competition among them may build up a condition of monopolistic competition. For an individual company in oligopolistic competition, prices are determined as illustrated by the following graph.

MC is the marginal costs; MR is the marginal revenues, while AC is the average costs. From the graph, profits are maximized when the marginal cost equals marginal revenues a point noted as equilibrium point (Anon, 2006). The industry faces two demand curves that are normal demand curve and marginal revenue curve that also act as a demand curve. At low prices, the firm faces fairly inelastic market demand.

The two market demand curves produce point p which is the firms’ price and maximum revenue point. Therefore, the market demand curve that the oligopolistic structures actually face is the kinked-demand curve (Anon, 2006). From the graph the kinked demand curve can be noted by points BCQ. Oligopolistic prices are determined where marginal costs intersect with marginal revenue curve.

Demand elasticity in oligopolistic markets

Oligopolistic markets demand curve are mostly kinked as indicated by the above graph. If for instance, one company increases its price above the equilibrium price p, it is assumed that the other firms in the industry will change their prices to affect the market price dynamism.

Alternatively, if one firm change prices and it assumes the role of price leadership other companies will be price takers (Riley, 2006). Ideally, the effect of price leadership and being price taker is caused by the kinked demand curve. In this case, firms will never change their prices in the short run since a small change may make companies loss customers.

Normally, firms in the industry assume price increases, as a strategy to achieve larger market share with lower prices advantages. Moreover, the elasticity will create small gain of customers if prices are largely decreased. This will consequently result into a price war among firms or industry developing cartels. In such case, in the long run new entrants will often enter the industry.

Game theory in oligopolistic markets

Shah, nd, indicates that game theory exists in oligopolistic structures and refers to approaches to gain a competitive position in terms of moves and counter interchanges. The strategic approach takes three elements that include firms, strategies and payoffs.

Cell phone industry is common example where game theory exists. Organizations such as Verizon and Sprint acts as players, their decisions on pricing and promotions act as strategies while the payoffs are profits or losses they make from such strategic moves.

Essentially, firms in the cellphone industry which is oligopolistic market will choose strategies with better payoffs which will further contribute to competitive advantage in the market (Shah, nd).

Profit maximization in oligopolistic structures

In an oligopoly market, the profit in firm is maximized at a point where marginal revenue curves intersect marginal costs curve. Oligopoly marginal revenue is also a demand curve, and the point where average costs and the demand curve meet determine the maximum profits.

According to Riley (2006), “kinked demand curve model predicts periods of relative price stability under an oligopoly with businesses focusing on non-price competition as a means of reinforcing their market position and increasing their supernormal profits”. Therefore, profits are maximized at an industry level while firms enjoy suboptimal equilibrium.

Oligopolistic markets benefits and disadvantages

Oligopolistic structures present a number of benefits and disadvantages to consumers. These are;

Benefits

Better quality of products and lower costs.
Extended services to customers since firms fight to retain customers at all costs.
High innovativeness and creativity on new products.
Discounts and promotions are largely utilized by competition thus consumers get all the information regarding certain products.
The contractual contacts usually exist between customers and producers.

Disadvantages

Oligopolistic competition in most cases leads to collusion of firms to form cartels which erodes the participation of consumers in [prices determination
The structure provide a platform of competition where prices a nd production is volatile. Prices are lowered and raised affecting buyer’s rationality.
Alliance of various firms to form cartels further brings about stabilization of unsteady markets which is a disadvantage to the economy.

References

Anon. (2006). Oligopoly. Web.

Riley, G. (2006). Oligopoly market structures overview. Eton College. Web.

Shah, A. (nd). Game Theory: Oligopolies. Web.

Thomas, C. R. & Charles, M. S. (2007). Managerial Economics (10th Ed). New York City: McGraw-Hill Higher Education.

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