Oligopoly
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Introduction
• Derived from Greek word: “oligo” (few) “polo” (to sell)
• A few dominant sellers sell differentiated or homogenous products under
continuous consciousness of rivals’ actions.
• Oligopoly looks similar to other market forms; as there can be many
sellers (like in monopolistic competition), but a few very large sellers
dominate the market.
• Products sold may be homogenous (like in perfect competition), or
differentiated (like in monopolistic competition).
• Entry is not restricted but difficult due to requirement of investments.
• One aspect which differentiates oligopoly from all other market forms, is
the interdependence of various firms: no player can take a decision
without considering the action (or reaction) of rivals.
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Features of Oligopoly
• Few Sellers: small number of large firms compete
• Product: Some industries may consist of firms selling
identical products, while in some other industries
firms may be selling differentiated products.
• Entry Barriers: No legal barriers; only economic in
nature
– Huge investment requirements
– Strong consumer loyalty for existing brands
– Economies of scale
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Features of Oligopoly
• Non Price Competition: Firms are continuously watching their
rivals, each of them avoids the incidence of a price war.
P
1
A
P
B
2
Market
share of
A
O Market
share of
B
• Two firms A & B sell a homogenous
product.
• Prevailing price is P1, but firm A lowers
the price.
• B fears loss of its customers and retorts
by lowering the price below that of A.
• A further reduces the price and this
process continues, till the firms reach P2.
• Both realize that this price war is not
helping either of them and decide to end
the war. Price stabilises at P2.
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Features of Oligopoly
• Indeterminate Demand Curve
Pric D
e
1
D
D
O
1
D
Quant
ity
• Price and output determination is very
complex as each firm faces two
demand curves.
• Demand is not only affected by its own
price or advertisement or quality, but
is also affected by the price of rival
products, their quality, packaging,
promotion and placement.
• When the firm increases the price it
faces less elastic demand (DD); when it
reduces the price it faces highly elastic
demand (D1D1)
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Duopoly
• Duopoly is that type of oligopoly in which only two players
operate (or dominate) in the market.
• Used by many economists like Cournot, Stackelberg, Sweezy,
to explain the equilibrium of oligopoly firm, as it simplifies the
analysis.
Price and Output Decisions
• No single model can explain the determination of equilibrium
price and output
– Difficult to determine the demand curve and hence the revenue curve
of the firm
– Tendency of the firm to influence market conditions by various
activities like advertisement, and fear of price war resulting in price
rigidity.
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Collusion and Competition
Oligopoly firms may collude (act as a monopoly)
and earn positive profits.
OR
Oligopolists may compete with each other and
drive prices down to where profits are zero.
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While it pays for firms to collude, in order to
earn positive profits, it also pays to cheat on
the collusive agreement. If one firm cuts its
price to slightly below the others, it could gain
a lot of business.
If everyone cheats on the agreement, however,
the agreement falls apart.
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Collusive agreements less likely
to succeed when
• secret price cuts are difficult and costly to detect.
(Quality changes are difficult to monitor.)
• market conditions are unstable. (Differences in
expectations make it difficult to reach an
agreement.)
• vigorous antitrust action increases the cost of
collusion.
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Some oligopolistic markets operate in a
situation of price leadership.
A single firm sets industry price and the
remaining firms charge the same price as
the leader.
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Kinked Demand Curve
• Paul Sweezy (1939) introduced concept of kinked demand curve to explain
‘price stickiness’.
• Assumptions
– If a firm decreases price, others will also do the same. So, the firm
initially faces a highly elastic demand curve.
– A price reduction will give some gains to the firm initially, but due to
similar reaction by rivals, this increase in demand will not be
sustained.
– If a firm increases its price, others will not follow. Firm will lose large
number of its customers to rivals due to substitution effect.
– Thus an oligopoly firm faces a highly elastic demand in case of price
fall and highly inelastic demand in case of price rise.
• A firm has no option but to stick to its current price.
• At current price a kink is developed in the demand curve
• The demand curve is more elastic above the kink and less elastic below
the kink.
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Kinked Demand Curve
(price and output determination)
Price,
Revenue, D1
Cost
MC1
K
P
MC2
A
S
T
D2
B
O
Q
Quantity
MR
• D1K = highly elastic portion of the
demand curve when rival firms do
not react to price rise
• KD2 = less elastic portion, when
rival firms react with a price
reduction.
• Kink is at point K.
• Discontinuity in AR (D1KD2) creates
discontinuity in the MR curve.
• At the kink (K), MR is constant
between point A and B.
• Producer will produce OQ, whether
it is operating on MC1 or MC2, since
the profit maximizing conditions are
being fulfilled at points S as well as
T.
• If MC fluctuates between A and B,
the firm will neither change its
output nor its price.
• It will change its output and price
only if MC moves above A or below
B.
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Summary
• Oligopoly is a market with a few sellers, differentiated or homogenous
product, interdependent decision making by firms, non price competition
and indeterminate demand curve.
• Duopoly is a special case of oligopoly, in which only two players operate
(or dominate) in the market. All the characteristics of duopoly are same
as those of oligopoly.
• Difficulty in determining the demand curve, tendency to influence market
conditions and fear of price war resulting in price rigidity are some of the
reasons which pose a major constraint in developing a model to explain
oligopoly.
• In Sweezy’s kinked demand curve model firms avoid a situation like price
war; therefore they stick to the current price. Thus the oligopoly price
remains rigid.
• The kink in demand curve signifies that the demand curve has two
different degrees of price elasticity.
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