Oligopoly

Characteristics

Few large producers

there are few large firms capturing most of the market.

Homogenous or differentiated product

firms may produce homogenous good e.g. steel mills, cement
producers etc.
they can also producer differentiated goods, e.g. automobiles,
electronics, cigarette brands etc.

Price control and interdependence

despite having control over prices, they consider the prices and
quantities sold of their rivals too.

Entry barriers
economies of scale and huge capital deter new entrants. For
exp. Petroleum refineries, aircraft manufacturers.

Mergers
some oligopolies emerge due to the merging of few competing
firms which gives them market dominance. For exp. OPEC

Price and Output Determination

Assumptions
There are three sellers; A, B, C
Producing homogenous good.
There marginal costs are same.
Their price and output decisions will be interdependent.
If B reduces its price, the demand for As and Cs
product would decrease and their demand curves will
shift downwards.
In reaction to this A and C would reduce their price to
capture the market.
This will be followed by another price reduction by B.
The price war will continue. It is in the best interest of
all the sellers to agree over some price level and
maximize their profits. The sellers may collude.

 Price and output in oligopoly

Types of Oligopoly
Collusive Oligopoly (Overt Collusion)
In overt collusion, the agreement over the prices
and output sold is not kept as a secret. The
agreements are the part of everyones knowledge.
For exp. OPEC

Covert Collusion
This is the type of the collusion which exists secretly in
the parts of the world where collusion is not legally
permitted. The agreements regarding the price and
output are not formally written but are the part of every
sellers understanding and knowledge.

Non collusive oligopoly

In non collusive oligopoly no secret and open
agreements take place w.r.t price and output.

Threats to Collusion
Cost difference and differentiated products
the difference in the cost of the firms can
break the price agreement.
Number of firms
when the number of firms increase, the
collusion can break down.
Cheating
due to the temptation of higher profits,
sellers are sometimes urged to cheat and
charge lower price.

Oligopoly

Non
Collusive
models

Collusive
Models

Formal

Informal

Cartels

Price
Leadership
model

Low Cost

Dominant
Firm

Bertrands
Model

Chamberlai
ns Model

Sweezy
Kinked
Demand
Curve
Model

Price Leadership Models

It is the type of covert collusion in which

one firm sets the price and others follow
it. Either it is advantageous for them or
they want to avoid uncertainty of their
rivals reaction.
It is relatively more flexible in a way that it
gives the members a freedom for their
product and selling activities.
If products are homogenous, prices will be
identical but if it is heterogeneous then
the movement of the prices will be in
same direction.

Low Cost Price Leadership Model

In this model, two firms are selling
identical goods.
The price of the dominant firm will be
charged and the firms will decide
how much to sell at that price level.
The dominant firm is one whos costs
are low.
The market can be equally shared
The market can be unequally shared

Dominant Price Leadership

Model
There is one dominant firm and many small
competing firms.
Dominant firm is the price setter.
All the small firms take dominant firms price as given
thus they act like the firms in perfect competition.
Commodity produced is homogenous.
So part of the market demand will be supplied by the
dominant firm and part of it will be supplied by other
small firms.
The dominant firms has huge market share and
supplies a large part of market demand.

Chamberlains model

There are two firms

Who produce homogenous goods
They are equal sized firms
Who face similar costs
Entry is blocked
Chamberlain argued that
both firms recognize each others importance
charge same price
Sell equal amounts of output
And maximize their profits without getting into any
agreement.

Sweezys Kinked Demand Curve model

This model was presented to show

the stickiness of the prices in the
oligopoly markets and thus help in
determining the equilibrium price
and output
Prices are rigid upwards in oligopoly
If a firm reduces its price, others will
follow it
But if a seller increases its price,
others wont follow suit.

 Proportional Demand Curve

It shows the effect upon the sales of the firm
that results from the change in the price which
the concerned firm charges. It shows the demand
of the product of the firm, when all other firms
change their prices simultaneously by the same
amount.

 Theres a kinked demand curve which the

seller in this model will face.
This demand arises from the intersection of
oligopolists demand curve and the
proportional demand curve.
Upper part of the kinked demand curve is
more elastic and the lower part is less elastic.
Theres a discontinuous region of the
marginal revenue curve corresponding to the
kink. In which the change in marginal cost
does not effect equilibrium price and output.
Costs does not effect prices in oligopoly.

Bertrands Model
In this model seller A assumes that
seller B will keep his price constant.
Thus to capture the market seller A
will reduce the price of its product.
In response to this seller B will
assume that seller A would not
reduce price any further, so seller B
will reduce the price of his product.
The price war continues till P=MC.