One of the economic impacts caused by oligopoly isinefficiency. There are several reasons due to which oligopoly is said to beinefficient. An essential factor that contributes to this is that oligopolymarket charges high prices to consumers. Charging high prices in oligopolyoften results from collusion among firms. This is because, collusion causesprice to be maintained high which is harmful to consumers. Collusion is wherethe collective verdict to collude among firms affects the whole marketsignificantly. Through collusion, firms benefit from avoiding pricedcompetition and wanting to agree on higher prices and protected sale volumes.
Aimof such collusion is to increaseindividual member’s profit by reducing competition. As all the competing firmshave colluded, they make an agreement which is generally illegal, with eachother where they can increase the price to a higher level. Due to this,oligopolies may earn a supernormal profit, however the consumers areexperiencing a huge exploitation.
This is because , they are spending more topurchase products that should be available at lower price. It is also evidentthat reducing the price of goods in oligopoly may increase its sales and marketshare. Hence, most probably colluded firms will cheat on the agreement theymade as cartels are usually unstable. Source:Other than that, output restriction in oligopoly alsoresults in high selling cost. This is because, oligopoly faces a downward sloping demandcurve. As a result, marginal revenue at each level of sales is lower thanproduct price (P > MR) and as the profit-maximising firm produces output atwhere marginal revenue equals to marginal cost (MR = MC), marginal cost willeventually be lower than price of goods (P > MC). Due to this, output isrestricted and prices are increased above the level of cost. Moreover, restriction on entry of newfirms causes additional restriction as in some oligopoly markets, producers endup creating a market that leads to inflation of price.
Although this isadvantageous for producer but this phenomena is nothing less than a nightmarefor consumers. Not only that, high promotional costalso contributes to high selling cost in oligopoly. This is because, producersin oligopoly market gets involved in many advertising tasks to increase theirsales. Hence, the resources are wasted in the form of high selling cost whichdoesn’t increase the satisfaction of customers. As oligopoly is producing output atwhere price is above minimum average cost (P > min ATC) and at where priceis more than marginal cost (P > MC), it is not both productively efficientand allocatively efficient respectively. This shows that oligopoly neitherproduces in the cheapest way nor produces the right amount of goods accordingto consumers demand. Therefore, oligopoly is neither productively efficient norallocatively efficient.
MARKET FAILURE AND EXTERNALITIES Anothereconomic impact caused by oligopoly is market failure and externalities. Ineconomics, market failure is a phenomena where a market allocates goods andservices inefficiently. This usually happens when price mechanism fails due toan externality or market power.
Externality is effect of an economic activitywhich affects a bystander, it can either be beneficial or harmful. A positiveexternality is a benefit that we receive from consuming or producing a good orservice. For example, water consumption of consumers who prefer drinkingbottled water has increased as bottled water is largely available in allgrocers and is also portable. On the other hand, negative externality is viceversa of positive externality. For example, huge backdrop of bottled water isthe waste. This is because when water is finished, the bottle still remains.
This is known as external cost as it brings negative impacts to society. Theconsumer will not have to pay social cost as he only pays for private costwhich is for bottled water. In such a case, society is forced to deal with thewaste. Negative externality usually occurs when social cost exceeds privatecost.
Consequently, externality does not matter to consumers as they ignoresocial cost. Hence, market failure occurs. Moreover,market power also contributes to market failure. This is because, market powerhas the capacity to influence market price of goods as it hold control overdemand and supply. Firms who are price makers have power to influence pricewhile other price taking firms has to accept the given price. For example, inoligopoly ‘cartel’, a formal agreement among existing firms is done.
The aim isto increase individual member’s profit by reducing competition. Due to this,new firms wanting to enter market will face barriers to entry. Consequently, itwill create market failure as market should be equilibrium where demand shouldequal supply..