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Oligopoly

Assumptions:
1. There are a small number of large firms.
2. High Barriers to entry similar to monopoly.
3. Products can be differentiated or homogenous.
4. Mutual Interdependence: decisions made by one firm affect
the decisions of other firms thus firms behavior.
Each firm in an oligopolistic market face conflicting incentives:
1. Incentive to collude
2. Incentive to compete
Oligopolistic firms also exhibit strategic behavior. They must consider
the behavior of other firms when making decisions of their own.
Concentration Ratio: provides the percentage outputs of the various
firms in the market place.
High concentration ratio implies less competition
Low concentration ratio implies higher concentration
Weaknesses to Concentration Ratio:
1. Does not represent competition from abroad.
2. Where a firm may be weak domestically, they may be dominant
globally.
Collusive Oligopoly
Agreement made by firms to limit competition, increase monopoly
power and increase profits.
Open/Formal Collusion Cartels
Formal agreement between firms with the aim of increasing profits:
1. Fixing price
2. Fixing quantity
3. Dividing locations by geographic locations
4. Agreeing to set up barriers to entry aggressive tactics similar
to monopoly
The goal of cartels is to limit competition thus acting like a monopoly.
The graph for a collusive oligopoly is that of a monopoly since the firms
are acting like a monopoly.

Oligopoly
Obstacles to forming a Collusive Oligopoly
1. Incentive to cheat
2. Each firm faces a different MC & MR curve sine each firms
demand curve is different.
3. Larger the number of firms the more difficult it is to collude.
4. Price wars
5. Recessions in an economy place strain on collusion because of
the incentive to cheat.
Informal Collusion

Implicit cooperation among firms

Price Leadership: one dominant firm in the marketplace with the


lowest costs sets and initiates any price changes. Firms are bound by
price but may compete in non-price competition.
Non-collusive Oligopoly Kinked Demand Curve

Firms do not agree to, formally or informally, to fix prices or


collaborate in any way.
The prices tend to be sticky. Once a price is set, it does not
change.
If the price changes do change, they tend to change for all firms
in the marketplace.
Assuming 3 firms: A, B, & C - Kinked Demand Curve

1. The Demand Curve above Pe is relatively elastic. This means if


Firm A raises its prices then Firms B & C will not change their
price and take some of the Market Share from A.
2. The Demand Curve below Pe is relatively inelastic. This means if
Firm A decreases its price, Firms B & C are likely to decrease their
price so as not to lose Market Share to Firm A. Thus firm A will
not gain any Market Share. This can start a price war.
3. So it is in the best interest of Firm A to settle on a price that lies
between the two MC curves thus leading to a sticky price.
Three important points to consider:
1. Firms that do not collude must take into account the actions of
their rival firms when making pricing decisions.
2. Even though there is no collusion, prices tend to be stable.

Oligopoly
3. Firms do not compete with each other based on price non-price
competition.