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Chapter 8

 Definition
 Characteristics
 Types of Oligopoly
 Kinked Demand Curve
 The firms equilibrium
 Come from the Greek word “Oligos”
means “ a little”
 a market structure with a few no of
large firms producing & supplying all
output in the market
 eg: Petroleum industry & steel
industry, Automobile manufacturers,
Personal Care Products, Cigarette
Manufacturers

 if there is only two firms in the


market, it’s known as “Duopoli”
 A few large firms
 Mutual interdependence
 Price rigidity(stable)
 homogenous or differentiated product
 Difficult to entry
 such as petroleum industry (Shell, BP,
Caltex, PETRONAS)
 makes a decision based on the reaction of
other firms in the industry
 eg: if General Motor increase it price,
the cars will be more expensive than
Ford’s.
the consumer will choose Ford’s cars
and this
will make General Motor lose
so, GM will reduce the price
 Price is rigid when it changes very slowly
over a period of time
 when 1 oligopolist firm increase price,
the others not follow because they can
steal the market share from the firm
– the firm will incur loss & has to decrease P
to avoid loss
– due to price interdependency, P can’t
changed
 some maybe have the same function but
different in brand name , shape, quality,
etc..
 eg: PETRONAS vs. Shell

these firm give the same function


(petrol)
but differ in brand name &
quality
 Legal barriers such as government
franchises, licenses & patents
 There have 2 types:
– perfect oligopoly
 All firms produced identical product
eg: steel industry
– imperfect oligopoly
 All firms produced differentiated product
Eg: automobile product
 Known as collusive oligopoly
 use the “Sweezy’s Model”
 Sweezy’s Model
– there 2 assumptions:
i) there are only 3 firms (A,B & C)
ii) they are interdependent
(there is no collusion between
them)
 Sweezy’s Model
– the shape of the oligopolists demand
curve depend on how the firm’s rival will
react to a price change introduce by
firm A.
 rivals will match a P , but ignore a P
 without any collusion
 Make P decision(price maker)
There are two possible reactions
 MATCH PRICE CHANGES
 IGNORE PRICE CHANGES
 if A reduce the P  B & C
 Another possibility is B & C
will follow ignore A’s price changed
 so, the increase in sales
 If A reduce price, B & C do not
for A is small, because B & changed the price
C also will gain the mkt  A will gain higher mkt share
share (sales increase substantially)
 If A increase in price  B &  If A increase price, and B & C do
C will follow not changed the price
 its sales will loss  A will lose big mkt share
modestly (sales drop substantially)
 Thus, Demand curve is  So, demand curve is less steep
steep & elastic
& demand curve is
P / cost
inelastic P / cost

AR = Dd
AR = Dd MR
MR
Qty Qty
The Kinked Demand
A combined strategy
Curve

a n
is
M R 1
tic ve
s
D 1 ela cur
Price

in d
a n
em
d

D1
MR1 Qty
The Kinked Demand
A combined strategy
Curve
Price

D2 MR2 is an
elastic
demand
curve Pe

D2
Pe & Qe are
equilibrium
price & eqb MR2
Qty D1
respectively
Qe
MR1 Qty
The Kinked Demand
A combined strategy
Curve
Price Rivals tend to
If the firm follow a price cut
raises the or ignore a
price from Pe price increase
to P1, other
P1
firm will not
follow, and Pe
the firm will
lose a mkt D2
share where
qty Dd
decrease
This is MR2
from
shown Qeonto Q1
D1
elastic Dd Qe MR
Q1 Qty
curve D2 1
The Kinked Demand
A combined strategy
If the firm lowers Curve
Price Rivals tend to
its price from Pe to
follow a price cut
P2, other firm will
forllow to avoid
losing a share mkt
to the firm which
lowers its price.
Lowering the price Pe
will increase the
Qty Dd from Qe to
Q
This
2. is the small
D2
increase because P2
other firm will also
lower the price &
they manage to
MR2
attain the same D1
share in the mkt. Qe
the situation is MR1 Q2 Qty
shown on elastic Dd
The Kinked Demand
A combined strategy
Curve
Price
Effectively creating
So the actual a kinked demand curve
Dd curve of
the firm
combination
of D1 & D2.
so the
demand D2
curve is
kinked
(as shown at
yellowline) MR2
D1
MR1 Qty
The Kinked Demand
A combined strategy
Curve
Price
Effectively creating
So the actual a kinked demand curve
Dd curve of
the firm
combination
of D1 & D2.
so the
demand
curve is
kinked
(as shown at
yellowline) D
MR Qty
 to maximize profit, the oligopolist firm
will not involve in price competition.
(price rigid)

 They will try to minimized cost of


production as lower as possible.

 Means the price is still fixed or same but


to get the maximum profit, they will
minimized cost as lowest as they can
afford to do it.
Price
Profit maximization
At higher
Marginal cost, C1,
MR = MC occurs
the output
at the kink
produced is Qe MC1
and the price at P
e
Pe A
The profit is area
A e1

D
Qe MR Qty
Price
If the frim becomes Profit maximization
more efficient, MC MR = MC occurs
will decrease MC1 to
at the kink
MC
The2 output produced MC1
is still at Qe at the
same price, Pe . MC2 Pe
The profit has A
increased to area MC2
A+B e1
So, without changing B
the price, the firm
can maximized profit
by reducing cost
efficiency in e2 D
production Qe Qty
MR
Profit is maximized when MR =
MC
Price As long as the curve intersect
at the vertical gap of MR curve,
the profit maximizing quantity
& price will be at kinked.

Pe = 50
MC
25 AC

17
8
D
Qe = 40 MR Qty
If the amount of MC is within
RM 8 to RM 25, the equilibrium
Price output will be 40 units and
price will be RM 50

Pe = 50
MC
25 AC

17
8
D
Qe = 40 MR Qty
Price
Qe = 40
units
Pe = RM 50
TR = P x Q
= 50 x
40 Pe =50
MC
= 2000
TC = AC x 25 AC
Q
= 17 x
40 17
∏ = = 680
TR - TC 8
= 2000 - D
680 Qe = 40 Qty
MR
= 1320
In order to max , firm will
try to minimize cost since
Price there is no competition in
Qe = 40 terms of price
units
Pe = RM 50
TR = P x Q
= 50 x
40 Pe =50
MC
= 2000
TC = AC x 25 AC
Q
= 17 x
40 17
∏ = = 680
TR - TC 8
= 2000 - 680 D
= 1320 Qe = 40 Qty
MR
(supernormal
Wat will happened when MC is
AT kinked point???
Price
MC
AC

Pe = 50

25

17
8
D
Qe = 40 MR Qty
Wat will happened when MC is
ABOVE kinked point???
Price MC
AC

75

Pe = 50

25

17
8
D
Qe = 40 MR Qty
Market Structure
Perfect Monopolistic
Characteristics
Competition Competition Oligopoly

Number of firms Very large Many Few


number
Barriers to entry None Low High
Market power None Some Substantial
(control over price
Type of product Standardized Differentiated Standardized
or
differentiated
Market Structure
Perfect
Characteristics Duopoly Monopoly
Competition
Number of firms Very large Two One
number
Barriers to entry None High High
Market power None Substantial Substantial
(control over price
Type of product Standardized Standardized Unique
or
differentiated
End of Chapter 8