Oligopoly

The Term “Oligopoly” has been derived from two Greek words.

‘Oligi’ which means few and ‘Polien’ means sellers.

Thus Oligopoly is an abridged version of monopolistic competition . It is a competition among few big sellers each one of them selling either homogenous or hydrogenous products.

Feller defines Oligopoly as “Competition among the few”.

In an Oligopolistic market the firms may be producing either homogenous products or may be having differentiation in a given line of production.

1. Few Sellers : An oligopoly market is characterized by a few sellers and their number is limited . (usually not more than 10) Oligopoly is a special type of imperfect market. It has a large number of buyers but a few sellers.

2. Homogeneous or Differentiated Product : The Oligopolists produce either homogenous or differentiated products. Products may be differentiated by way of design , trademark or service

3. Interdependence : The most important feature of the Oligopoly is the interdependence in decision making of the few firms which comprise the industry.

The reactions of the rival firms may be difficult to guess. Hence price is indeterminate under Oligopoly.

4. High Cross Elasticities : The cross elasticity of demand for the products of oligopoly firms is very high. Hence there is always the fear of retaliation by rivals.

Each firm is conscious about the possible action and reaction of competitors while making any change in price or output

6. Competition : Competition is unique in an oligopoly market. It is a constant struggle against rivals.

7. Different size : The size of firm in an oligopoly market. It is a constant struggle against rivals.

8. Group Behaviour : Each Oligopolist closely watches the business behaviour of other Oligopolists in the industry and designs his moves on the basis of some assumptions of their behaviour .

9. Uncertainty : The interdependence of other firms for one’s own decision creates an atmosphere of uncertainty about price and output

10. Price Rigidity : In an oligopoly market each firm sticks to its own price to avoid a possible price war. The price remains rigid because of constant fear of retaliation from rivals.

11. Indeterminate or Kinked Demand Curve : The interdependence of firms and the inability of a particular firm to predict the behavior of other firms make the demand curve of an Oligopolistic firm indefinite and indeterminate.

The demand curve of an oligopolist loses its definiteness and determinates and goes on constantly shifting as the rivals change their prices in responds to the prices change made by the firm . According to Paul Sweezy, firms in an oligopoly market have a kinky demand curve for their products.

Because of interdependence , an oligopolistic firm cannot assume that its rival firms will keep their quantities constant when it makes changes in price or quantity. When an oligopolistic firm changes its prices, its rival firms would retaliate and change their prices which in turn would affect the demand of the former firm.

Oligopoly can be classified into several forms. Some of the important forms of Oligopoly are as follows

1. Perfect and Imperfect Oligopolies : If the product of the rival firm are homogenous then it is Perfect Oligopoly, if the product are differentiated it is Imperfect Oligopoly.

2. Open and Closed Oligopolies : If entry is open to new firms it is termed as Open Oligopoly, and if entry is strictly restricted it is termed as Closed Oligopoly.

3. Collusive Oligopoly : If the firms under oligopoly market combine together instead of competing it is known as Collusive Oligopoly. The collusive may take place in the form of a common agreement or an understanding between the firms.

4. Partial and Full Oligopoly : Partial oligopoly is formed when the dominant firm which is the price leader and all other firms follow the price of the price leader. If no firm acts as a price leader then it is called Full Oligopoly.

Types of oligopoly( w.r.t category)

COLLUSIVE OLIGOPOLY

• oligopoly in which two or more than two firms are making an agreement or determination of price and output.

• Supply is curtailed so that the price does not go low.

Types of collusive oligopoly

cartel

• In which two or more than two firms are making an agreement on determination of price and output

• Shortest way of controlling/earning profit by controlling the supply.

Cartel as a monopolist

Quantity per periodQ0

MC

D

MR

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Cartel as a monopolist

A cartel acts as a monopolist.Here, D is the market demand curve, MR the associated marginal

revenue curve, and MC the horizontal sum of the marginal cost curves of cartel members (assuming all firms in the market join the cartel).

Cartel profits are maximized when the industry produces quantity Q and charges price p.

Examples of Cartels

• Example of Walls and Olpers products. Olpers has come up with a new product of

Omore ice cream which is giving tough competition to Walls ice cream

Result is a 30%-40% decrease in the profits of Walls within a period of 6 months.

Profit sharing cartel

• Collusive pricing model reveals that firms in the market agree on production limits and set a common price to maximize the joint profit.

• When firms collude and agree on common price so mostly they earn Economic profit.

• It is assumed here that firms have identical cost data and same demand and thus Marginal revenue data.

Difficulties in collusion

• Collusion among Corporations is difficult because of;

• Demand and Cost Differences among Seller

• The Complexity of Output Coordination among Producers

• The Potential for Cheating

• The Potential Entry of New Firms

MARKET SHARING CARTEL

• Gives each member the right to operate in a particular geographic area.

• Most notorious example of this cartel:• Du pont and Imperial chemicals agreeing to

divide market.

Price leadership

• The firms in the Oligopolistic industry without any formal agreement accept the price set by the leading firm in the industry and move their prices in line with the prices of the leader firm.

• Price Leadership can be in any of the forms;

• Price Leadership by a Dominant firm

• Barometric Price Leadership

• Aggressive or Exploitative Price Leadership

Equilibrium under Price Leadership

MR0

MC a

MC b

AB

XY

Rev

enue

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t/P

rice

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Output

Non collusive oligopoly

• That oligopoly in which two or more firms are making an independent decision about their price and output determination, keeping in view the reaction of other firms operating in the market.

• One firm’s action effects other firm’s profit• The response is to be kept under considered

during the competition analysis because say if the supply by all the firms exceeds demand the price would go down and adversely affect all the firms in the market.

Models in non-collusive oligopoly

• Cournot Model

• Bertrand model

• Chamberlin model

• Kinked Sweezy model

• Stackleberg model

Because of interdependence , an oligopolistic firm cannot assume that its rival firms will keep their quantities constant when it makes changes in price or quantity. When an oligopolistic firm changes its prices, its rival firms would retaliate and change their prices which in turn would affect the demand of the former firm.

Economists have established a number of price-output models for Oligopoly market, depending upon the behaviour pattern of the members of the group. A few important ones are as follows :

1. Avoidance of Interdependence : Some economists have assumed that oligopolist firms ignore interdependence . When interdependence disappears from decision making the demand curve facing the oligopolist becomes determinate.

2. Price Leadership : Another approach is that the firms in an Oligopoly would accept one firm as a leader and would follow him in setting prices. Such a leader firm may be dominant or low-cost firm producing a very large proportion of the total production and having a great influence over the market.

3. Price Wars : Some economists assume that an oligopolist is able to predict the counter moves of his rivals, and they provide a determinant solution to the price and output problem.

4. Game Theory : In the theory of games, the oligopolistic firms does not guess at it’s rivals reaction pattern, but calculates the optional moves by rival firms. It calculates their best possible strategies and in view of that adopts its policies and counter moves.

5. Non-price competition : Since the oligopolists face the danger of retaliation in price cut competition, they resort to non-price competition. This can take the from of advertising, sales promotion , improvement of the product etc.

6. Secret Price Concessions : Since an open price cut is retaliated by rivals, some oligopolists offer secret price concessions for selected buyers.

From the above analysis it is clear that there is no single determinant solution to the price output fixation under Oligopoly. The fixing of price under oligopoly market situation is very difficult.

In many oligopolistic industries, prices remain sticky or inflexible for a long time even though the economic conditions change. Many explanations have been given for this price rigidity under Oligopoly and the most population explanation is the Kinked Demand Curve Hypothesis given by an American economist Paul Sweezy.

According to the kinked demand curve hypothesis, the demand curve facing the Oligopolist has a ‘Kink’ at the level of the prevailing price. The kink is formed at the prevailing price level because the segment of the demand curve above the prevailing price level is highly elastic and the segment of the demand curve below the price level is inelastic.

The figure shows a kinked demand curve dD with a kink at point k. the prevailing price is OP and the firm produces and sells OQ output. The upper segment dk of the demand curve dD is relatively elastic and the lower segment kD is relatively inelastic.

The differences in elasticity's is due to the particular competitive reaction pattern assumed by kinked demand curve hypothesis. The assumed pattern is “Each Oligopolist believes that if he lowers the price below the prevailing level, his competitors will follow him and accordingly lower their prices, whereas if he raises the price above the prevailing level, his competitors will not follow his increase in price”

A } Price Reduction : If an oligopolist reduces the price below the prevailing price to increase sales, the competitors will fear that their customers would go away from them and buy from the firm which has made a price cut. Therefore, in order to retain it’s customers, they will also lower the prices. Besides the competitors quickly follow the price reduction by an oligopolist, he will gain only very little sales.

Thus the segment kD of the demand curve which his below the prevailing price OP is inelastic showing that very little increase in sales is obtained

B } Price Increase : If an oligopolist raise the price above the prevailing price level, there will be a substantial reduction in sales. as a result of price rise, its customers will withdraw from it and go to its competitors who welcome new customers will gain in sales. The oligopolist who raises its price will lose a great deal and therefore, refrain from increasing price.

The segment dK of the demand curve which lies above the current price level OP is elastic following a large fall in sales if a producer raises his price.

Each oligopolist will find himself in such a situation that on one hand, he expects rivals to match his price cuts very quickly and on the other hand, he does not expect his rivals to match his price increase .

Given this expected competitive pattern, each oligopolist will have a kinked demand curve dD, with the upper segment dK being relatively elastic and the lower segment kD being relatively inelastic

C } Price Rigidity : An oligopolist facing a kinked demand curve will have no incentive to raise its price or lower it. The Oligopolist will not gain any larger share of the market by reducing his price below the prevailing level. There will be a substantial reduction in sales if he increasing the price above the prevailing level. Each Oligopolist will adhere to the prevailing price seeing no gain in changing it.

The prevailing price is OP at which a kink is found in the demand curve dD . The price OP will remain stable or rigid as every Oligopoly firm will find no gain to lower it or increase it. Thus rigid or sticky prices are explained according to the kinked demand curve theory.

1. The oligopoly model provides a theoretical explanation as to why stable prices exist in oligopolistic industries. But it takes prevailing prices as given and provides no justification as to why that price level rather than some other is the prevailing price

i.e. the kinked demand model can be viewed as incomplete.

2. Stigler had tested the kinked demand curve empirically on several oligopolies. He found that oligopolistic rivals are just as likely to follow price increase as price decreases indicating little support for the kinked demand curve.

3. The kinked demand Oligopoly theory does not apply to oligopoly cases of price leadership and price cartels.

4. In case of pure oligopoly, the kinked demand curve does not provide adequate explanation for price rigidity.

5. The explanation of price stability by Sweezy’s kinked demand curve theory applies to depression periods. In periods of boom and inflation, when the demand for the products increase, price is likely to rise rather than remain stable.

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