Transcript oligopoly - The Toppers Way

LECTURE 1
 OBJECTIVES:
Students should be able to:
 Identify and explain the characteristics of
oligopoly.
Imperfect Competition among the FEW
OLIGOPOLY
• Definition
 A market structure in which a few firms dominate the
supply of an industry’s output and compete with each
other for markets.
Market Structure
 Oligopoly – Competition amongst the few
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Industry dominated by small number of large firms
Many firms may make up the industry
High barriers to entry
Products could be highly differentiated – branding or homogenous
Non–price competition
Price stability within the market - kinked demand curve?
Potential for collusion?
Abnormal profits
High` degree of interdependence between firms
OLIGOPOLY
 Example
 Car industry
 Airline industry
 Cigarettes
 Cleaning products
 Electrical appliance
Characteristics
Implication of market domination
 Strong mutual interdependence among dominant
firms in their price and output decisions.
Characteristics
 Homogeneous or Differentiated Products
 Homogeneous product- pure oligopoly eg. Raw
materials (oil, petrol, tin)
 Differentiated product- imperfect/ differentiated
oligopoly eg. Cars, energy drinks.
Characteristics
 Barriers to Entry
 Substantial barriers, similar to monopoly but not as
restrictive eg. Petroleum industry
Characteristics
o Non-price competition
 Compete not through price but other methods
(advertising, after-sales service, free gifts)
NON-PRICE COMPETITION
 Practiced by oligopoly and monopolistic competition.
 Various forms:
 Competitive advertising – to reinforce product
differentiation and harden brand loyalty.
 Promotional offers – eg. Household detergent, toothpaste,
shampoo (buy 2 get 1 free), (25% extra at no extra cost).
 Extended guarantees/after sales service – esp. for consumer
durables, by offering free spare parts, labour guarantee.
 Better credit facility
 Attractive gift wrappings
 Price Rigidity
 Prices are very inflexible
 Despite changes in underlying costs of production,
firms are often observed to maintain prices at a
constant level.
 Collusion
 Make agreement amongst themselves so as to restrict
competition and maximise their own benefit.
1.PRICE DETERMINATION MODELS
 CARTELS
 PRICE LEADERSHIP
2. PRICE RIGIDITY MODELS
 KINKED DEMAND CURVE THEORY
1.PRICE DETERMINATION MODELS
 Collusive models
 Non Collusive models
Collusive models assumes that there is an agreement between
firms to fix prices or mutually divide the market.
Firms work together and act like a profit maximizing monopolist.
 There are two types of collusion-
1. cartel
2. Price leadership
Cartel is is an agreement between firms to fix
prices or mutually divide the market.
1. PRICE DETERMINATION MODELS
 PRICE LEADERSHIP
 Usually there is a price leader in oligopoly collusion to
determine price.
 Price leadership is of various types 1. Price leadership of dominant firm- this firm is producing
large proportion of the total production in the industry and
has great influence over the market. This firm estimates its
own demand curve and fixes the price which maximizes its
own profits.
 2. Price leadership of barometric firm- this is an old
experienced, largest and most respected firm assumes the role
of a custodian who protects the interest of all. This firm fixes
price which are the best from the point of view of all the firms
in the industry.
 3. Price leadership of Exploitative firm- this firm is very
large and establishes its relationship by following
aggressive price policies and thus compel the other firms in
the industry to follow him in respect of prices.
2. PRICE RIGIDITY MODEL
 THE KINKED DEMAND CURVE THEORY
 (reaction model) Paul Sweezy 1930’s
 This model recognises that demand for a firm’s
product is determined both by the market demand for
a product as well as by rival firm’s behaviour
£
Kinked demand for a firm
under oligopoly
Current price
and quantity
give one point
on demand curve
P1
O
Q1
fig
Q
£
Stable price under conditions of a kinked
demand curve
MC2
MC1
P1
a
D = AR
b
O
Q
Q1
MR
KINKED DEMAND CURVE THEORY
 If the firm lowers its price below OP1, its rivals will
follow.
 Its demand will expand along the relatively inelastic
section of the demand curve below OP1
and total revenue will fall.
KINKED DEMAND CURVE THEORY
 If the firm raises its price above OP1, none of its
competitors will follow.
 Its demand for prices above OP1 will contract along the
relatively elastic section of the demand curve and total
revenue will fall.
 As a result of action and non-reaction to price changes,
an oligopolist is faced with a kinked demand curve at
OP1.
 Price rigidity is due to the kinked demand curve and
the resulting discontinuity in the MR curve.
 Note: An oligopolistic firm faces a relatively more
ELASTIC DDcurve at prices ABOVE a given market
price and a relatively more INELASTIC DD curve at
prices BELOW a given market price.
 Changing cost conditions
 Even though MC may be rising or falling, MC=MR in
the portion of discontinuity will leave price and output
unchanged at OP1 and OQ1.
 Ie. Changes in costs has no effect on profit maximising
price and out put because the firm is still producing
where MC=MR.
ADVANTAGES OF OLIGOPOLY
 When firms collude – monopoly –supernormal profit –
extra profit – extra capital – to fund R&D – benefit to
consumer.
 Product differentiation – non-price competition–
greater variety to consumers.
 Price stability/rigidity – helps in planning, reduce
uncertainty.
DISADVANTAGES OF OLIGOPOLY
 Collusive oligopoly
 if they agree upon output – no variety and improvement
in quality – bad for consumers.
o Acting like a monopoly
 Restrict output and charge a higher price
 Producer sovereignty
 Consumer sovereignty not respected
 Greater inequality in income (supernormal profits)