A Oligopoly is a market structure in which a few firms sell either a standardized or differentiated product into which entry is difficult in which the firm has limited control over product price because of mutual interdependence (except when there is collusion among firms) and in which there is typically non-price competition.
Characteristics of oligopoly
1. few NUMBER OF FIRMS
i) Mutual interdependence– A situation in which a change in price strategy (or in some other strategy) by one firm will affect the sales and profits of another firm (or other firms); any firm which makes such a change can expect the other rivals to react to the change.
ii) Collusion possible– A situation in which firms act together and in agreement (collude) to fix prices divide a market or otherwise restrict competition.
2. TYPE OF PRODUCT
homogeneous oligopoly – An oligopoly in which the firms produce a standardized product.
differentiated oligopoly – An oligopoly in which the firms produce a differentiated product.
3. CONTROL OVER PRICE
limited by mutual interdependence– A situation in which a change in price strategy (or in some other strategy) by one firm will affect the sales and profits of another firm (or other firms); any firm which makes such a change can expect the other rivals to react to the change.
4. EASE OF ENTRY
i) economies of scale: costs
c) natural monopolies
ii) legal barriers
a) patents b) licenses
iii) ownership of essential raw materials
iv) pricing and other strategic barriers
5. NON-PRICE COMPETITION
Non-price competition is much related to differentiated product.
Price and Output Determination
A. No Standard Model But Common Pricing Characteristics
1. Why no common model
a) Diversity of specific market situations
b) Collusion possible– A situation in which firms act together and in agreement (collude) to fix prices divide a market or otherwise restrict competition.
c) Mutual interdependence– A strategy in which one firm’s product is distinguished from competing products by means of its design, related services, quality, location, or other attributes (except price).
2. Common pricing characteristics
a) prices tend to be inflexible
b) when prices do change, firms tend to change prices together
B. Three Oligopoly Pricing Models
1. kinked demand: non-collusive oligopoly
3. Price leadership
1. Kinked Demand: Non-collusive Oligopoly
i) Kinked Demand Curve
IMPORTANT: based on the assumption that rivals will:
– follow a price decrease, and
– ignore a price increase.
ii) demand and MR curve
– If competitors IGNORE price increases.A firm will expect demand will be elastic (flatter) when it increases price.From the total-revenue test, we know raising prices when demand is elastic will decrease revenue.So the non-colluding firm will not want to raise prices.
– If competitors MATCH price decreases.The individual firms believe that rivals will match any price cuts.Therefore, each firm views its demand as inelastic (steeper) for price cuts,which means they will not want to lower prices since total revenue falls when demand is inelastic and prices are lowered.
2. Cartels and Other Collusion
Definition – Collusion is to maximize profits, the firms collude and agree to a certain price. Assuming the firms have identical cost, demand, and marginal-revenue date the result of collusion is as if the firms made up a single monopoly firm.
i) OPEC Cartel
Cartel: A formal agreement among firms in an industry to set the price of a product and the outputs of the individual firms or to divide the market for the product geographically.
Obstacles to collusion
a. Differing demand and cost conditions among firms in the industry;
b. A large number of firms in the industry;
c. The temptation to cheat;
d. Recession and declining demand;
e. The attraction of potential entry of new firms if prices are too high; and
f. Antitrust laws that prohibit collusion.
3. Price Leadership
Definition– An informal method which firms in an oligopoly may employ to set the price of their product: one firm (the leader) is the first to announce a change in price and the other firms (the followers) soon announce identical or similar changes.
Price leadership in oligopoly occasionally breaks down and sometimes results in a price war.
A recent example occurred in the breakfast cereal industry in which Kellogg had been the traditional price leader.