MIDLANDS STATE UNIVERSITY

FACULTY OF COMMERCE

DEPARTMENT OF BUSINESS MANAGEMENT

Program: Master of Commerce in Strategic Management and Corporate Governance.

Module: Managerial Economics

Level: 1.2

Group 2

NAME SURNAME REG NUMBER

Antoneta Nikisi R171394V

Movement Musasiwa R2313186N

Natasha Munjere R231830Y

Mercy Machona R14932C

Lloyd Kakunguwo R091609W

Queen Ruvimbo Ndlovu R2311446T

Tendai Rwafa R1815337Q

Walter Mutanga R239783N

QUESTION 2: OLIGOPOLY
  OLIGOPOLY MEANING AND SOURCES
 CONCENTRATION RATIOS, THE HERFINDAHL INDEX AND
CONCESTABLE MARKETS
 THE COURNOT MODEL
 THE KINDKED DEMAND CURVE MODEL
 PROFITABILITY AND EFFICIENCY IMPLICATIONS OF THE OLIGOPOLY
 PORTER’S STRATEGIC FRAMEWORK

INTRODUCTION

Oligopoly refers to a market structure characterized by a small number of dominant firms that
control a significant portion of the market share (A Beresteanu, 2024). In an oligopolistic
market, a few large companies typically compete with one another, often resulting in
interdependence among them (Bodere 2023). These firms have the ability to influence market
conditions and their competitors' actions due to their substantial market power. A rule of
thumb is that an oligopoly exists when the top five firms in the market account for more than
60% of total market sales (Kenton, 2019). In Zimbabwe examples of Oligopoly firms include
the telecommunication industry, which is dominated by Econet, Net one and Telecel. We also
have Lobels, Baker’s inn and Proton as examples of oligopoly firms.

The key features of an oligopoly include:

Small number of firms: There are only a few major firms operating in the market. The exact
number can vary, but typically, the market is shared among a handful of significant players
(M Rubens - American Economic Review, 2023). For instance, in Zimbabwe there are very
few but large firms operating in the telecommunication industry and these firms include
Econet, Net one and Telecel. They are the only participants in the telecommunication
industry making them an oligopoly market. Bakers’ inn, Lobels and Proton bread also makes
an Oligopoly market.

Barriers to entry: Oligopolies often have significant barriers to entry, which make it difficult
for new firms to enter the market and compete with the existing players. These barriers can
be in the form of high capital requirements, strong brand loyalty, access to distribution
channels, or technological advantages (Azar, 2021). The need for high capital investment
needed in setting up an oligopoly firm makes it difficult for new entrants in the market. For

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example, if one wants to start a telecommunication company, there is need for high
technological machines which may be too expensive for individuals who wish to enter the
market. In another case, Lobels was shutting down and they decided to sell their equipment
but they failed to get individuals who were willing to purchase the equipment that they used
because of how expensive these equipments were, this forced Lobels to look for funds to
revive the company and start over since they could not just leave their assets idle.

Interdependence: The actions of one firm in an oligopoly can have a direct impact on the
other firms in the market. This interdependence arises due to the firms' awareness of their
mutual dependence and the recognition that their decisions can trigger reactions from
competitors (G Gecheva, 2021). This leads to strategic decision-making, where firms
consider their rivals' likely responses when formulating their own strategies.

Non-price competition: Oligopolistic firms often engage in non-price competition, focusing

on product differentiation, branding, marketing, and other factors besides price. This allows
them to maintain market share and reduce the intensity of price competition, which could
potentially erode profits for all firms in the market. They focus more on developing a unique
selling point for their products to fight competition instead of using prices because of demand
elasticity and demand inelastic (Moghadam, 2015). This is why Econet have become a
learning organisation so that it continuously improves its operations to fight its competitors
since there is no price competition in this industry. For example, in Zimbabwe the price of
sim cards is relatively the same for all the companies but what differentiate them is the
functions of that sim card.

The sources of oligopoly can vary depending on the industry and market conditions. Here
are some common sources:

Economies of scale: Oligopolies may arise in industries where economies of scale are
significant (Zhou,2024). Large-scale production allows firms to reduce costs and maintain a
competitive advantage over smaller competitors. This cost advantage creates barriers to entry,
limiting the number of firms in the market.

Government regulations and licenses: In certain industries, government regulations and

licensing requirements can limit the number of firms that can operate. These regulations may
be in place to ensure safety, maintain quality standards, or control scarce resources. Such

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restrictions can lead to oligopolistic markets. The requirements demanded by government for
one to start up a company can also led to oligopolistic markets (Zhou, 2024).

Technological superiority: Oligopolies can form when a few firms possess advanced
technology, patents, or proprietary knowledge that provides them with a competitive edge.
This advantage makes it difficult for new entrants to compete effectively, resulting in a
concentration of power among a small number of firms. In Zimbabwe few firms who possess
advanced technology include Net one, Telecel and Econet because they have invested in
expensive machines which makes it difficult for others to invest in such a market.

Mergers and acquisitions: Oligopolies can be the result of mergers and acquisitions, where
companies combine their operations and market shares, (Wang, 2022). This consolidation
allows firms to increase their market power, reduce competition, and potentially enhance
their profitability (Gecheva, 2021). An example of firms who practiced mergers is Pick n pay
and Tm to increase their market power in retail.

Strategic behaviour: Firms in competitive industries may engage in strategic behaviour,

such as collusion or tacit cooperation, to limit competition and maintain their market
positions. These actions can lead to an oligopolistic market structure.

Brand loyalty: Customers may be strongly attached to established brands, making it hard for
new firms to gain a foothold. Oligopolists often have strong brand images built through years
of marketing and advertising (Gecheva, 2021). When customers are happy with the existing
brands' products and services, they're less likely to seek out new entrants. Established brands
may have a reputation for quality, reliability, or positive experiences that new firms struggle
to match. Additionally, switching to a new brand can involve costs like learning a new
product or service, which can further deter customers. Brand loyalty makes it challenging for
new firms to compete with established oligopolists.

Oligopoly concentration ratios, the Herfindahl-Hirschman Index (HHI), and contestable

Markets are all concepts related to the measurement and analysis of market concentration and

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competition within oligopolistic industries. Let's explore each of these concepts in more
detail:

Oligopoly Concentration Ratios: Oligopoly concentration ratios are measures that indicate
the extent to which a market is concentrated among a few dominant firms, (Bodere, 2023).
These ratios typically express the market share held by the largest firms in the industry.
Common concentration ratios include the 4-firm concentration ratio (CR4) and the 8-firm
concentration ratio (CR8), which represent the combined market share of the top four or top
eight firms, respectively, (Prat, 2022). Higher concentration ratios indicate a more
concentrated market with fewer firms holding a significant market share. A rule of thumb is
that an oligopoly exists when the top five firms in the market account for more than 60% of
total market sales (Kenton, 2019). If the concentration ratio of one company is equal to
100%, this indicates that the industry is a monopoly.

Example Calculation: Assume that ABC Inc., XYZ Corp., GHI Inc., and JKL Corp. are the
four largest companies in the biotechnology industry, and an economist aims to calculate the
degree of competition. For the most recent fiscal year, ABC Inc., XYZ Corp., GHI Inc., and
JKL Corp. have market shares of 10%, 15%, 26%, and 33%, respectively. Consequently, the
biotech industry's four-firm concentration ratio is 84%. Therefore, the ratio indicates that the
biotech industry is an oligopoly.

Herfindahl-Hirschman Index (HHI): The Herfindahl-Hirschman Index is a widely used

measure of market concentration. It is calculated by summing the squares of the market
shares of all firms in the market. The HHI ranges from 0 to 10,000, with higher values
indicating greater concentration (Moghadam, 2015). The HHI can provide a more nuanced
measure of market concentration than concentration ratios because it takes into account the
market shares of all firms, rather than just the top few. In general, an HHI below 1,500
suggests a competitive market, while an HHI above 2,500 indicates a highly concentrated
market. It is also used to determine market competitiveness, often pre- and post-merger and
acquisition (M&A) transactions. The closer a market is to a monopoly, the higher the
market's concentration (and the lower its competition).

If, for example, there were only one firm in an industry, that firm would have 100% market
share, and the HHI would equal 10,000, indicating a monopoly. If there were thousands of

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firms competing, each would have roughly 0% market share, and the HHI would be close to
0, indicating nearly perfect competition.

Pros and Cons of the HHI: The primary advantage of the HHI is the simplicity of the
calculation and the small amount of data required for the calculation (Bromberg, 2023). Also,
firms are weighted according to their size, which makes the HHI superior to other measures,
like the concentration ratio. The primary disadvantages of the HHI stem from the fact that it
is such a simple measure that it fails to take into account the complexities of various markets
in a way that allows for a genuinely accurate assessment of competitive or monopolistic
market conditions.

Contestable Markets: The concept of contestable markets, developed by economist William

Baumol, suggests that the degree of competition in a market depends not only on the number
of firms but also on the ease with which new firms can enter and compete with incumbents,
(Bond-Smith, 2022). In a contestable market, even if there are only a few dominant firms, the
threat of potential entry by new competitors can discipline the behaviour of existing firms and
promote competitive outcomes, (Bond-Smith, 2022). The key idea is that if barriers to entry
and exit are low, incumbents will have to act competitively to prevent new entrants from
taking their market share.

The concept of contestable markets challenges the traditional view that a large number of
competitors is necessary for competition to be effective. It emphasizes the importance of
potential competition and the ability of new firms to challenge incumbents, even in
oligopolistic industries.

Strengths of Contestable Markets:

 Promotes Efficiency: The threat of new entrants in a contestable market incentivizes

existing firms to be more efficient. They may lower prices, improve product quality,
or innovate to stay competitive and avoid being undercut by new players. This can
benefit consumers who get better deals and potentially see more innovation.
 Reduces Barriers to Entry: The core idea of contestability is that markets should be
open to new firms. This can lead to a more dynamic and competitive environment,
potentially breaking the dominance of existing oligopolists.
 Regulatory Tool: The concept of contestability can inform policy decisions. By
identifying and reducing barriers to entry in certain industries, governments can
encourage competition and potentially improve market outcomes.

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Weaknesses of Contestable Markets:

 Limited Practicality: In reality, many factors can make entry difficult, even in
theory. Economies of scale, high capital requirements, brand loyalty, and government
regulations can all act as significant barriers, limiting the contestability of many
markets.
 Hit-and-Run Competition: Contestable markets might encourage "hit-and-run"
entry, where new firms enter only to exploit temporary high profits and then leave.
This can create uncertainty and instability in the market.
 Unsustainable Price Wars: The constant threat of new entrants could lead to intense
price competition in contestable markets. While this might benefit consumers in the
short term, it could lead to price wars that are ultimately unsustainable for all firms,
potentially harming investment and innovation.

In summary, oligopoly concentration ratios and the Herfindahl-Hirschman Index provide

measures of market concentration, indicating the dominance of a few firms in a market.
These measures help assess the level of competition and antitrust concerns. On the other
hand, the concept of contestable markets focuses on the potential for competition,
highlighting the role of entry and exit barriers in influencing market dynamics, even in
oligopolistic industries.

The Cournot model

It is an economic model used to analyse competition between firms in an oligopolistic

market. It was developed by the French mathematician and economist Antoine Augustin
Cournot in 1838 and is named after him. The Cournot model is one of the earliest formal
models of oligopoly behaviour.

In the Cournot model, firms make strategic decisions about the quantity of output they will
produce, taking into account the anticipated reaction of their competitors. The model assumes
that firms choose their output levels simultaneously and independently, based on their
expectations of how other firms will behave. This means that firms do not coordinate or
collude with each other.

Key assumptions of the Cournot model include:

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Number of firms: The market consists of a few competing firms, typically two, although the
model can be extended to multiple firms.

Homogeneous products: Firms produce identical or homogeneous products, meaning there

is no differentiation between the products of different firms. For instance the products or
services produced by Econet, Net one and Telecel are relatively the same.

Quantity competition: Firms choose the quantity of output to produce rather than setting
prices.

Profit maximization: Firms seek to maximize their profits based on their cost structures and
market demand.

Perfect information: Firms have perfect information about their own costs and the market
demand conditions.

 The Cournot model is based on the concept of "reaction functions," which represent how
each firm's output choice depends on its expectation of the output choice of its
competitors. The reaction function for each firm shows the quantity it will produce as a
function of its competitors' expected quantities.
 The equilibrium in the Cournot model occurs when each firm's output choice is consistent
with the output choices of all other firms. This equilibrium is known as the Cournot-Nash
equilibrium, named after Cournot and John Nash, who independently developed the
concept of Nash equilibrium.
 The Cournot model provides insights into how firms' output choices and market outcomes
are affected by factors such as the number of firms in the market, the slope of the demand
curve, and the cost structures of the firms. It helps to analyse strategic interactions and the
resulting market equilibrium in oligopolistic industries.

It's important to note that the Cournot model represents a simplified view of oligopoly
behaviour and makes certain assumptions that may not fully capture all the complexities of
real-world markets. Nonetheless, it remains a valuable tool for understanding the dynamics of
quantity competition in oligopolies.

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The kinked demand curve model is an economic theory that seeks to explain price rigidities
and stability in oligopolistic markets. It was developed by economist Paul Sweezy in the
1930s as an alternative to the traditional demand and supply model.

The key assumption of the kinked demand curve model is that firms in an oligopoly
anticipate and respond to the reactions of their competitors, particularly in relation to price
changes. The model suggests that firms face a demand curve with a kink or bend at the
current prevailing price level. Above the prevailing price, the demand curve is highly elastic,
meaning that a small increase in price would lead to a significant decrease in quantity
demanded by consumers. Below the prevailing price, the demand curve is relatively inelastic,
indicating that a decrease in price would result in only a small increase in quantity demanded.
The Kinked Demand curve is shown in the Fig below:

The kink in the demand curve arises from the asymmetric response of competitors to price
changes. Specifically, it assumes that firms expect their rivals to match price decreases to
prevent losing market share, while they anticipate no reciprocal response to price increases.
This assumption reflects a belief that competitors are more likely to match price cuts rather
than price increases due to the fear of losing customers.

As a result of this asymmetry, the kinked demand curve model predicts that prices tend to be
"sticky" or inflexible, remaining relatively stable over time. If a firm were to increase its price
above the prevailing level, it would face a significant reduction in demand as consumers
switch to the relatively lower-priced products of its competitors. On the other hand, if a firm
were to decrease its price below the prevailing level, it would not gain a substantial increase

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in demand, as competitors are expected to match the price cut and prevent the firm from
capturing a larger market share.

The stability of prices in the kinked demand curve model can lead to periods of price rigidity
and a lack of significant price competition among firms in an oligopoly. This can result in a
relatively stable market equilibrium, with firms focusing on non-price competition, such as
product differentiation, advertising, and quality improvements, to gain a competitive
advantage.

It's important to note that the kinked demand curve model has been subject to criticism and is
considered a relatively simplistic representation of oligopoly behaviour. It relies on a number
of assumptions about the behaviour and expectations of firms, which may not always hold in
real-world markets. Nonetheless, the model provides insights into the dynamics of price
stability and non-price competition within oligopolistic industries.

Oligopoly, characterized by a small number of large firms dominating a market, has

several profitability and efficiency implications. Here are some key considerations:

Market Power and Profitability: Oligopolistic firms often possess significant market power
due to their size, market share, and barriers to entry,(Ma, 2022). This market power allows
them to influence market prices and earn economic profits. By colluding or engaging in tacit
coordination, oligopolistic firms may restrict output and collectively raise prices, resulting in
higher profit margins.

Non-Price Competition: Oligopolistic firms tend to engage in non-price competition to

differentiate their products and capture market share. This can include investments in
advertising, branding, research and development, and product innovation, (Wang, 2022).
While non-price competition can be costly, it allows firms to create barriers to entry and
maintain profitability.

Strategic Interdependence: Oligopolistic firms closely monitor and respond to the actions
of their competitors. This strategic interdependence can lead to intense competition and
strategic behaviours aimed at gaining a competitive advantage (J Sandford - Available at
SSRN 3939860). Firms may engage in strategic pricing, product positioning, and other tactics
to protect or enhance their market position. These strategic interactions can affect
profitability and efficiency in the industry.

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Efficiency Effects: Oligopolies may experience efficiency gains due to economies of scale
and the ability to invest in research and development, (Dou, 2022). Large firms in oligopoly
can achieve cost advantages by spreading fixed costs over a larger output, leading to lower
average costs. Additionally, the profits earned by oligopolistic firms can be reinvested in
research and development to drive innovation and technological advancements, improving
efficiency in the long run.

Lack of Allocative Efficiency: Oligopolistic markets may face allocative inefficiencies, as

prices may be higher and output lower compared to a perfectly competitive market. The
exercise of market power by oligopolies can result in prices that are above marginal cost,
reducing consumer surplus and leading to a misallocation of resources, (Gecheva, 2021).

Potential for Collusion: Oligopolistic firms may collude to restrict competition and maintain
higher prices and profits. Collusive behaviour can lead to reduced efficiency and consumer
welfare as it limits the benefits of market competition. Collusion can take various forms, such
as explicit agreements, tacit understandings, or cartel behaviour.

Impact on Innovation: Oligopoly can have mixed effects on innovation. On one hand, the
presence of large firms with financial resources can foster innovation by investing in research
and development. On the other hand, the lack of competitive pressure and the potential for
barriers to entry may reduce incentives for firms to innovate.

Overall, the profitability and efficiency implications of oligopoly depend on various factors,
including market structure, firm behaviour, strategic interactions, and the presence of
competition. While oligopolies can benefit from market power and economies of scale,
concerns about market efficiency and consumer welfare arise due to reduced competition and
potential collusion. Regulatory oversight and competition policies are often implemented to
mitigate these concerns and promote market efficiency in oligopolistic industries.

Porter's strategic framework, also known as Porter's Five Forces framework, can be
linked to oligopoly and provide insights into the competitive dynamics within an
oligopolistic market. Here's how each force in Porter's framework relates to oligopoly:

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Threat of New Entrants: The threat of new entrants refers to the risk posed by new
competitors entering an industry and challenging existing players. When new firms can easily
enter an industry, it affects the competitive landscape and profitability of existing firms.
Oligopolistic markets typically have high barriers to entry, which serve as a deterrent for
potential new entrants, (Zhou, 2024). These barriers can include economies of scale, access to
distribution channels, high capital requirements, established brand loyalty, and legal or
regulatory barriers. The presence of a few dominant firms in an oligopoly makes it difficult
for new entrants to establish a foothold and compete effectively. The threat of new entrants is
generally low in oligopolistic markets. For instance in the telecommunication industry now, it
is difficult to enter that industry because of the high investment in technological machines
that the three companies have invested in over a long period of time which makes it
expensive to enter that same market.

Bargaining Power of Suppliers: The bargaining power of suppliers refers to the ability of
suppliers to influence the terms and conditions of their business relationships with buyers.
When suppliers have significant bargaining power, they can impact buyers in several ways,
like, Suppliers with significant bargaining power can exercise their influence in various ways:

 Price Setting: Suppliers with high bargaining power can demand higher prices for
their products or services, potentially impacting a buyer’s costs and profit margins
 Terms and Conditions: Powerful suppliers may impose strict terms and conditions
on their buyers, affecting contractual agreements, payment schedules, or delivery
requirements.
 Availability of Resources: If suppliers control essential or unique resources, they can
limit the availability of those resources to buyers, potentially causing disruptions in
production or service delivery.
 Switching Costs: Suppliers can influence buyers by making it costly or challenging
for them to switch to alternative suppliers.

In an oligopoly, suppliers may have significant bargaining power if they are few in number
and provide unique or critical inputs. Oligopolistic firms may rely on a limited number of
suppliers, making it difficult to switch or negotiate favourable terms, (Zhou, 2024). This can
give suppliers leverage to demand higher prices, better terms, or exert control over the quality

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and availability of inputs. The bargaining power of suppliers can impact the profitability and
strategic decisions of firms in an oligopoly.

Bargaining Power of Buyers: The bargaining power of buyers refers to the influence and
control that customers or consumers have over businesses. Buyers can exert pressure on firms
to provide higher quality products, better customer service, and/or lower prices. Oligopolistic
firms often face a small number of large and powerful buyers. These buyers can exert
significant bargaining power by demanding lower prices, better terms, or higher quality
products. Oligopolistic firms may need to accommodate buyer demands to maintain their
market share or risk losing key customers. The bargaining power of buyers influences the
pricing strategies, product offerings, and overall competitiveness of firms in an oligopoly
(Ganapati, 2024). In an oligopoly market structure, consumers typically have limited
bargaining power due to the small number of large firms dominating the market.

Zimbabwe’s life insurance industry is also more of an oligopoly. Four major players include,
First Mutual Life, Old Mutual and Nyaradzo, these hold a market share of about 88% and
these firms maintain their position through barriers to entry and making it challenging for
new competitors to enter the market. In an oligopoly market like Zimbabwe’s life insurance
industry: While large corporate clients paying millions of dollars in premiums have
bargaining power, with online aggregators and the emergence of social media, today’s
individual policyholders are a force. With instantaneous awareness of coverages, pricing, and
services, modern buyers demand more personalized attention and care for the premiums paid,
(Kulkarni, 2020).

Threat of Substitute Products: The threat of substitutes is one of Porter’s Five Forces that
determines the intensity of competition within an industry. It arises when consumers can
easily switch from one product or service to another that serves a similar purpose or satisfies
the same need. The threat of substitute products is relevant in oligopolistic markets, as
competitors may offer similar products or services that can satisfy customer needs. The
availability of close substitutes can limit the pricing power of firms in an oligopoly and
increase competition. Oligopolistic firms need to differentiate their products or create barriers
to entry to mitigate the threat of substitutes and maintain their market position.

Intensity of Rivalry: The intensity of rivalry refers to the extent to which firms within an
industry puts pressure on one another. The intensity of rivalry is a key feature of oligopoly. In
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an oligopolistic market, a small number of large firms compete for market share and profits.
The rivalry can be intense due to the interdependence and strategic interactions among these
firms (Beresteanu, 2024). Oligopolistic firms closely monitor and respond to each other's
actions, leading to aggressive competitive behaviour such as price wars, product innovation,
advertising battles, or non-price competition. The intensity of rivalry in oligopoly can impact
profitability, market stability, and the overall competitive landscape.

By considering Porter's Five Forces framework in the context of oligopoly, firms operating in
such markets can assess the competitive dynamics, identify strategic opportunities and
threats, and develop effective strategies to navigate the challenges of intense competition and
market concentration.

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