Oligopoly

Kinked demand curve theory

This was developed in the late 1930s by the American Paul Sweezy. The theory aims to explain the price rigidity that is often found in oligopolistic markets. It assumes that if an oligopolist raises its price its rival will not follow suit, as keeping their prices constant will lead to an increase in market share. The firm that increased its price will find that revenue falls by a proportionately large amount, making this part of the demand curve relatively elastic (flatter).

Conversely if an oligopolist lowers its price, its rivals will be forced to follow suit to prevent a loss of market share. Lowering price will lead to a very small change in revenue, making this part of the demand curve relatively inelastic (steeper).

The firm then has no incentive to change its price, as it will lead to a decrease

in the firm's revenue. This causes the demand curve to kink around the present market price. Prices will further stabilize as the firm will absorb changes in its costs as can be seen in the diagram below. The marginal revenue jumps (vertical discontinuity) at the quantity where the demand curve kinks, the marginal cost could change greatly - e.g., MC1 to MC2 (between prices a and b)- and the profit maximizing level of output remains the same.

An oligopoly is an economic condition in which there are so few independent suppliers of a particular product that competitive pricing does not take place. Oligopoly is a form of market where there is domination of a limited number of suppliers and sellers called Oligopolists. A situation in which a particular market is controlled by a small group of firms.

An oligopoly is much like a monopoly, in which only one company exerts control over most of a market. In an oligopoly, there are at least two firms controlling the market. An oligopoly is a market dominated by a few large suppliers. The degree of market concentration is very high. Firms within an oligopoly produce branded products and there are also barriers to entry. Another important characteristic of an oligopoly is interdependence between firms. This means that each firm must take into account the likely reactions of other firms in the market when making pricing and investment decisions. This creates uncertainty in such markets - which economists seek to model through the use of game theory. The retail gas market is a good example of an oligopoly because a small number of firms control a large majority of the market. Economics is much like a game in which the players anticipate one another's moves. Game theory can also be applied in this situations as if decision makers must take into account the reasoning of other decision makers. It has been used, for example, to determine the formation of political coalitions or business conglomerates, the optimum price at which to sell products or services, the best site for a manufacturing plant, and even the behavior of certain species in the struggle for survival.

The ongoing interdependence between businesses can lead to implicit and explicit collusion between the major firms in the market. Collusion occurs when businesses agree to act as if they were in a monopoly position. KEY FEATURES OF OLIGOPOLY - A few firms selling similar product - Each firm produces branded products - Likely to be significant entry barriers into the market in the long run which allows firms to make supernormal profits. - Interdependence between competing firms. Businesses have to take into account likely reactions of rivals to any change in price and output THEORIES ABOUT OLIGOPOLY PRICING There are four major theories about oligopoly pricing: (1) Oligopoly firms collaborate to charge the monopoly price and get monopoly profits (2) Oligopoly firms compete on price so that price and profits will be the same as a competitive industry (3) Oligopoly price and profits will be between the monopoly and competitive ends of the scale (4) Oligopoly prices and profits are "indeterminate" because of the difficulties in modelling interdependent price and output decisions Distinct features of an oligopolistic market: - An oligopolistic market comprises a handful of firms, engaged in selling analogous products - All oligopolistic markets increase mutual dependence among the firms involved in similar competition. It also prepares businessmen to accept the outcomes arising from rivalries with respect to alterations in the production and prices of goods. - In near future, an oligopolistic market is likely to impose restrictions on admission, in an attempt to incur abnormal profits. - Each of the business houses involved with this market produces branded goods THE IMPORTANCE OF PRICE AND NON-PRICE COMPETITION Firms compete for market share and the demand from consumers in lots of ways. We make an important distinction between price competition and non-price competition. Price competition can involve discounting the price of a product (or a range of products) to increase demand. Non-price competition focuses on other strategies for increasing market share. Consider the example of the highly competitive UK supermarket industry where non-price competition has become very important in the battle for sales - Mass media advertising and marketing - Store Loyalty cards - Banking and other Financial Services (including travel insurance) - In-store chemists / post offices / creches - Home delivery systems - Discounted petrol at hyper-markets - Extension of opening hours (24 hour shopping in many stores) - Innovative use of technology for shoppers including self-scanning machines - Financial incentives to shop at off-peak times - Internet shopping for customers Price leadership: Oligopolistic market The dominance of one firm in the oligopolistic market results in price leadership. Firms having less market shares only follow the prices fixed by leaders. Oligopolistic competition: Effects - Oligopolistic competition in most cases leads to collaboration of the business firms on issues like raising the prices of various goods and subdue production process. - Under other given market conditions, the competition between the sellers acquires a violent form, on the grounds of lowering the prices and increasing the production. - Collaboration of various firms also brings about stabilization in the unsteady markets. PRICE LEADERSHIP IN OLIGOPOLISTIC MARKETS When one firm has a dominant position in the market the oligopoly may experience price leadership. The firms with lower market shares may simply follow the pricing changes prompted by the dominant firms. We see examples of this with the major mortgage lenders and petrol retailers. In reality, it is the Oligopoly market which exists, having a high degree of market concentration. This indicates that a huge percentage of the Oligopoly market is occupied by the leading commercial firms of a country. These firms require strategic planning to consider the reactions of other participants existing in the market. This is precisely why an oligopolistic market is subject to greater risk of connivances.
By: Schafaq Chohan
An oligopoly is a market form in which a market or industry is dominated by a small number of sellers. Barriers to entry are high.