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how to be a successful oligopolistic firm in the long run

It is a well-known fact that every firm wants to be successful in its business. Sometimes it is difficult to decide what kind of actions to take in order to achieve it. Especially, it is hard on oligopoly market because this is one of the most complicated market structures. Oligopoly includes many models and theories such as duopoly where are just two producers and which pricing decisions remind monopoly, kinked demand curve, which decreases economic profit, and cartel, which brings economic profit just for the short-run. However, to be a successful oligopolistic firm in the long run, managers should include in the planning process such economic theories and models as producer interdependence, the prisoner’s dilemma, price leadership, nonprice adjustments, and correct using of barriers to entry.
The essential factor of an oligopolistic firm is interdependence. Oligopoly involves few producers, which means more than one producer as it is in pure monopoly but not so many as in monopolistic competition or pure competition where it is difficult to follow rival firms’ actions. Therefore, due to small number of producers on oligopoly market, the price and output solutions are interdependent. As a result, firms can cooperate or come to an agreement profitable for everyone. Therefore, they can increase, as it is possible, their joint profits (Pleeter & Way, 1990, p.129). Further, oligopoly is divided on pure, which is producing homogeneous products, and differentiated, producing heterogeneous products (Gallaway, 2000). Economists Farris and Happel insist that the more the product is differentiated, the more firms become independent, and the more the product differentiation, “the less likely joint profit maximization exists for the entire group” (1987, p. 263). Consequently, it is worth to be interdependent.
Another factor on the way to success on oligopoly market is understanding and using with advantage the game theory, in particular, prisoner’s dilemma. Game theory, a mathematical approach to strategic behavior, was stated by John von Neumann and Oscar Morgenstern in 1944 (Farris & Happel, 1987, p. 267). Game theory is useful in analyzing the actions in any strategic situation, from a game of chess to the pricing and output decisions of oligopoly firms where firms cooperate or conflict. The classic game is the prisoner’s dilemma:
Confess do not confess
Confess 6 8
6 1
Do not 1 2
Confess 8 2

Numbers are years in prison for each arrested player considering different behaviors of each prisoner. Without interaction with each other, Jane probably will confess that they committed crime, no matter what Kate does, because she will spend the smallest number of years in prison. The same will do Kate. Therefore, both will confess even though it would be better if both do not confess. Of course, the result depends on players’ personalities and on how many times this “game” was played (Farris & Happel, 1987, p. 268). Other results can be that one of them confesses, and another one does not. As a result the one who confesses spends just a year in prison, and that one who denies committing of crime is sentenced for 8 years. And the last result is when both deny and get two years. This happens when the “game” is repeated, so the “players” agreed on this decision before. Oligopolistic firms can also put the prisoner’s dilemma into practice. For example, a group that consists of several firms does not have any economic profit. If they come to an agreement, they can increase price, bound output, and raise group profits. On the other hand, when one firm decreases price a little bit, its profit increases much because now the customers of other firms are attracted more to new prices. So the firm should take a decision if it wants to be together with the group or to start price wars that can again bring everyone to no economic profit (Farris & Happel, 1987, p. 268).
Moreover, firms involved in oligopoly should be aware of price leadership. Price leadership has three models. First one is price leadership of a low cost firm, which sets price according to its low costs. And other firms in that industry follow it to prevent price wars because they realize that they will lose their customers attracted to the lowest price set by the low cost firm (Farris & Happel, 1987, p. 269). Second model is price leadership of a dominant firm, very large and mostly old firm that is dominant on the market. “Because of the size of the dominant firm’s production/selling capabilities compared to those of the smaller firms that surround it, the smaller firms act as a competitive fringe and follow the dominant firm’s price changes either out of fear of convenience” (Farris & Happel, 1987, p. 270). This dominant firm’s desire is to behave like a monopoly by ignoring the fringe. However, antitrust laws do not let it be. Examples for the dominant firms can be several U.S. firms such as American Tobacco, General Motors, Coca-Cola, and so on (Farris & Happel, 1987, p. 270). And the third model is barometric price leadership. Farris and Happel say that a firm is the barometer for other firms in the industry. It increases price considering changes of the market. However, it is the other firms’ choice whether to follow it or not. They have reasons such as “cost disadvantages or fear of retaliation” (Farris & Happel, 1987, p. 273) not to follow it, but they also have many reasons to do opposite. For example, other firms can respect and trust the barometric firm very much. But this barometric firm should be ready that any time it can loose respect and other firm can be the price leader (1987, p. 273). Examples for barometric firms can be some U.S. firms such as U. S. Steel and Bethlehem producing steel, American Tobacco and R.J. Reynolds producing cigarettes, Firestone and Good-year producing tires, and so on (Farris & Happel, 1987, p. 273). To solve problems of dominant and barometric price leadership, some firms decide to form cartel, “formal collusive agreements on price and relative market shares” (Farris & Happel, 1987, p. 273) that behaves like unreal pure monopoly organized by several firms and. The short-run results are figured with the help of the graph below:

Pc S = MC

0 Qc Qpc

(Farris & Happel, 1987, p. 273)
“In a purely competitive industry, equilibrium is at the point where the market demand curve (D) and the market supply curve (S = MC) intersect, giving rise to price Ppc and output Qpc” (Farris & Happel, 1987, p. 274). When the firm constitutes a cartel, assuming other things are constant, the equilibrium changes its position (Qc; Pc) (Farris & Happel, 1987, p. 274). The cartel does not use the demand curve because they prefer to use the marginal revenue curve when calculating how much output they should produce (Farris & Happel, 1987, p. 274). Therefore, the price is higher and the output is smaller which is more profitable for the firms. However, it is profitable just for the short-run because the prisoner’s dilemma will appear (Farris & Happel, 1987, p. 274). Economists insist that “because of the lure of large short-run profits, and because firms do not want to be last if price cutting occurs, …price cuts by existing firms are inevitable” (Farris & Happel, 1987, p. 275). Therefore, cartel is not the way to successful business on oligopoly market for the long-run.
Not less important for the success of oligopolistic firms are nonprice adjustments. Instead of price issues sometimes it is better to concentrate on nonprice issues in oligopoly because the producers are interdependent. In order to be more successful than the firm’s competitors, the firm tries to stand out by changing product quality or advertising that brings an increase in demand and personal market shares. The quality changes can be achieved by research and technology development (McCarty, 1986, p. 344). For example, “the four largest pharmaceutical manufactures in the United States spend between 4 percent and 6 percent of each sales dollar on research, amounting to hundreds of millions on dollars annually”(McCarty, 1986, p. 344). And producers of computers try to develop their product technologically in order to feel secure on the oligopoly market (McCarty, 1986, p. 344). Advertising is also very helpful as a nonprice adjustment. Its policy focuses on different factors than the price policy. The price policy of a firm is to concentrate on making the demand (D) more elastic:

Pa Aa

0 Qa Q
On the graph, there is a movement along the demand curve (D) from A to Aa that causes the increase in price (Pa) and decrease in quantity (Qa). They do it to get more economic profit. However, advertising policy is focused on shifting the curve of demand from D to Da:

D Da
0 Q Qa
They do it in order to increase total sales at the same or increased prices. Therefore, the firm should show while advertising that its product is better than other products on the market in its industry giving other reasons than a low price of the product (McCarty, 1986, p. 355).
And the last theory to put into practice, in appropriate way, in order to advance on oligopoly market is barriers to entry. For the firm to be economically profitable is hard even though the number of competitors is constant. Therefore, it is harder when new firms enter the oligopoly market of their industry. Consequently, it is better to make barriers to enter their industry. This action will eliminate their rivals. There are different types of barriers: conditions of the demand and cost, legal barriers such as copyrights, patents, or trademarks, or illegal such as different kinds of forces or collusion (Farris & Happel, 1987, p. 275).
In sum, the underlying theme of this paper was to research what a firm needs to know and use to survive and, moreover, advance in its industry on the oligopolistic market for the long run. This is producer interdependence, the prisoner’s dilemma, price leadership, nonprice adjustments, and uses of barriers to entry. And if a firm follows them, it will be successful in the future.

Farris, M. T. & Happel, S. K. (1987). Modern managerial economics. London: Scott, Foresman and Company.
Gallaway, J. H. (2000, August 28). Market structure: Oligopoly. [WWW document]. URL** [2000, November 28]
McCarty, M. H. (1986). Managerial economics with applications. London: Scott, Foresman and Company.
Pleeter, S. & Way, P. K. (1990, April). Economics in the news. Addison-Wesley Publishing Company, Inc.

References Farris, M. T. & Happel, S. K. (1987). Modern managerial economics. London: Scott, Foresman and Company. Gallaway, J. H. (2000, August 28). Market structure: Oligopoly. [WWW document]. URL [2000, November 28] McCarty, M. H. (1986). Managerial economics with applications. London: Scott, Foresman and Company. Pleeter, S. & Way, P. K. (1990, April). Economics in the news. Addison-Wesley Publishing Company, Inc.

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