Oligopoly Regulation

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.

Fig. 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.

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