Oligopoly MarketOligopoly Market

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Price and Output Determination Under OligopolyPrice and Output Determination Under Oligopoly

Oligopoly is defined as the market structure in which Oligopoly is defined as the market structure in which there are a few sellers selling a homogeneous or there are a few sellers selling a homogeneous or differentiated products.differentiated products.

Selling homogeneous products – pure oligopoly. Selling homogeneous products – pure oligopoly. Example : industries producing cement, steel, petrol, Example : industries producing cement, steel, petrol, cooking gas, chemicals, aluminium and sugar. cooking gas, chemicals, aluminium and sugar.

Selling differentiated products – differentiated Selling differentiated products – differentiated oligopoly. Examples: Automobiles, TV sets, soft oligopoly. Examples: Automobiles, TV sets, soft drinks, computers, cigarettes etc. drinks, computers, cigarettes etc.

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Features of OligopolyFeatures of Oligopoly

Small number of sellers : There is a small number of sellers Small number of sellers : There is a small number of sellers under oligopoly. Conceptually, however, the number of sellers is under oligopoly. Conceptually, however, the number of sellers is so small and the market share of each firm is so large that a so small and the market share of each firm is so large that a single firm can influence the market price and business strategy single firm can influence the market price and business strategy of the rival firmsof the rival firms

Interdependence of decision making : The competition between Interdependence of decision making : The competition between the firms takes the form of action, reaction, and counteraction the firms takes the form of action, reaction, and counteraction between them. Since the number of firms in the industry is between them. Since the number of firms in the industry is small, the business strategy of each firm in respect of pricing, small, the business strategy of each firm in respect of pricing, advertising, product modification is closely watched by the rival advertising, product modification is closely watched by the rival firms firms

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Indeterminate Demand Curve: No firm under oligopoly Indeterminate Demand Curve: No firm under oligopoly faces the determinate demand curve due to uncertainty faces the determinate demand curve due to uncertainty of the reactions of rivals.Due to the reactions the firm of the reactions of rivals.Due to the reactions the firm keeps on shifting its demand curve.If one firm changes keeps on shifting its demand curve.If one firm changes the price demand for its product depends on the reaction the price demand for its product depends on the reaction of its rival for the change in price. of its rival for the change in price.

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Conti…Conti…

Barriers to entry arise due to such market Barriers to entry arise due to such market conditions as :conditions as :

Huge investment requiredHuge investment required Economies of scaleEconomies of scale Strong consumers loyaltyStrong consumers loyalty Patents, trademarks,tariff,quota,licencing and other Patents, trademarks,tariff,quota,licencing and other

government regulations create artificial barriers to entry government regulations create artificial barriers to entry of the firms.of the firms.

Existing firms can resort to the price cuttingExisting firms can resort to the price cutting

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Advertising: With the high cross elasticity of demand Advertising: With the high cross elasticity of demand for products, the oligopolist can raise his sales through for products, the oligopolist can raise his sales through non- price competition either by advertising or by non- price competition either by advertising or by improving the quality. Both the ways can shift the improving the quality. Both the ways can shift the demand curve in his favour.The oligopolist may adopt demand curve in his favour.The oligopolist may adopt regressive advertising to sweep market. regressive advertising to sweep market.

Group Behaviour: there is no general acceptable Group Behaviour: there is no general acceptable theory of group behaviour . The group behaviour in this theory of group behaviour . The group behaviour in this market is unpredictable due tomarket is unpredictable due to

1.1. Firms in the group may have no common objectivesFirms in the group may have no common objectives

2.2. The firm may enter into formal or nonformal collusion The firm may enter into formal or nonformal collusion to achieve profit maximisation goal by avoiding to achieve profit maximisation goal by avoiding uncertainity and ruinous rivalaryuncertainity and ruinous rivalary

3.3. Group may dominated by a leader. Group may dominated by a leader.

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Collusive Oligopoly: CartelsCollusive Oligopoly: Cartels

In order to avoid uncertainty arising out of interdependence and In order to avoid uncertainty arising out of interdependence and to avoid price wars and cut throat competition, firms working to avoid price wars and cut throat competition, firms working under oligopolistic conditions often enter into an agreement under oligopolistic conditions often enter into an agreement regarding a uniform price – output policy to be pursued by them. regarding a uniform price – output policy to be pursued by them. The agreement may be either formal or secret. when the firms The agreement may be either formal or secret. when the firms enter into such secret agreements, collusive oligopoly prevails.enter into such secret agreements, collusive oligopoly prevails.

Collusion is of two types:Collusion is of two types:a) Cartels.a) Cartels.b) Price Leadership. b) Price Leadership.

a) In a cartel type of collusive oligopoly, firms jointly fix a price a) In a cartel type of collusive oligopoly, firms jointly fix a price and output policy through agreements.and output policy through agreements.

b)Under Price Leadership one firm sets the price and others b)Under Price Leadership one firm sets the price and others follow it. The one which sets the price is a price leader and the follow it. The one which sets the price is a price leader and the one who follow him are his followers.one who follow him are his followers.

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Joint Profit Maximisation Cartel :Joint Profit Maximisation Cartel : In this the firms In this the firms producing homogeneous products surrender their price producing homogeneous products surrender their price and output decisions to a centralised cartel board in the and output decisions to a centralised cartel board in the industryindustry

The individual firms surrender their price & output The individual firms surrender their price & output decisions to this board . Board determines output quota decisions to this board . Board determines output quota for the firms, the price to be charged and distribution of for the firms, the price to be charged and distribution of industry profits.industry profits.

The central board thus acts as a single monopolist to The central board thus acts as a single monopolist to maximise the joint profits of the oligopolistic industry. maximise the joint profits of the oligopolistic industry.

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Assumptions:Assumptions: Only two firms A & B are assumed in the oligopolistic industry.Only two firms A & B are assumed in the oligopolistic industry. Each firm is selling homogeneous products.Each firm is selling homogeneous products. Number of buyers is largeNumber of buyers is large The market demand curve is given and is known to the cartel.The market demand curve is given and is known to the cartel. Cost curves are different but known to the cartelCost curves are different but known to the cartel Price of the product determines the policy of the cartelPrice of the product determines the policy of the cartel Cartel aims at the joint profit maximisation.Cartel aims at the joint profit maximisation.

Distribution of Profits and advantages:Distribution of Profits and advantages: The joint profit is the sum of profits generated by the two firms The joint profit is the sum of profits generated by the two firms

based on the pooling agreement.based on the pooling agreement. Avoids the price warAvoids the price war Joint profits are generally more than the individually earned profitsJoint profits are generally more than the individually earned profits

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Price and output determination under cartel: - Joint profit Price and output determination under cartel: - Joint profit maximizationmaximization

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Price Leadership:Price Leadership: It is imperfect collusion among the oligopolistic firms in It is imperfect collusion among the oligopolistic firms in

an industry when all firms follow the lead of one big form.an industry when all firms follow the lead of one big form. There is a tacit agreement among the firms to sell the There is a tacit agreement among the firms to sell the

product at a price set by the leader of industry.product at a price set by the leader of industry. If products are homogeneous, a uniform price is set by If products are homogeneous, a uniform price is set by

the leader. It can be the same in case of the the leader. It can be the same in case of the differentiated products also.differentiated products also.

If there is change in the price the leader announces from If there is change in the price the leader announces from time to time and the firms follow.time to time and the firms follow.

In America Examples of the Price Leadership industries In America Examples of the Price Leadership industries are Biscuits, cement, cigrattes,fertilizers,milk steel ,etc. are Biscuits, cement, cigrattes,fertilizers,milk steel ,etc.

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Price leadership (low- cost model)Price leadership (low- cost model)• In the low cost price leadership model ,an oligopolist firm In the low cost price leadership model ,an oligopolist firm

having lower costs that other firms sets a lower price having lower costs that other firms sets a lower price than other firms and this other firms have to follow. than other firms and this other firms have to follow.

Assumptions:Assumptions:• There are two firms A and B. Firm A has Lower cost than There are two firms A and B. Firm A has Lower cost than

B.B.• Costs of the two firms are different.Costs of the two firms are different.• They have identical MR curves. Each of the two firms They have identical MR curves. Each of the two firms

have equal share in the market.The demand curves have equal share in the market.The demand curves faced by them is half of the market demand curve.faced by them is half of the market demand curve.

• Number of buyers is largeNumber of buyers is large• Market demand curve is known to both the firms.Market demand curve is known to both the firms.

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Price and Output Determination Under Low-Cost Price Price and Output Determination Under Low-Cost Price Leadership.Leadership.

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The Dominant firm Price Leadership Model:The Dominant firm Price Leadership Model:

One large dominant firm and a number of small firms One large dominant firm and a number of small firms exist in the industry.exist in the industry.

Dominant firm fixes the price for the entire industryDominant firm fixes the price for the entire industry Other firms act as the price takersOther firms act as the price takers Dominant firm alone is capable of estimating the demand Dominant firm alone is capable of estimating the demand

curve for the productcurve for the product The dominant firm is able to predict the supply curve of The dominant firm is able to predict the supply curve of

the other firmsthe other firms

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Price Leadership By The Dominant FirmPrice Leadership By The Dominant Firm

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Panel (a) where demand curve DD market demand curve for the product.Panel (a) where demand curve DD market demand curve for the product.

At each price the leader is able to sell the part of the market demand not At each price the leader is able to sell the part of the market demand not fulfilled by the supply from the small firms.fulfilled by the supply from the small firms.

Thus at price P1 small firms supply the whole of quantity of the product Thus at price P1 small firms supply the whole of quantity of the product demanded and at that price. The demand for product for the leader is zero.demanded and at that price. The demand for product for the leader is zero.

At OP2 price the small firms supply P2C and the remaining part CT of the At OP2 price the small firms supply P2C and the remaining part CT of the MD will constitute the demand for the leaders product.MD will constitute the demand for the leaders product.

The demand curve for the leader is in the panel (b)by curve dl. P2Z in the The demand curve for the leader is in the panel (b)by curve dl. P2Z in the panel (b) is equal to CT in panel (a).panel (b) is equal to CT in panel (a).

At price P3 the supply of the product by the small firms is zero.At price P3 the supply of the product by the small firms is zero.

The whole market demand P3U will be satisfied by the price leader.The whole market demand P3U will be satisfied by the price leader.

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The MR1 is the marginal revenue curve of the price leader The MR1 is the marginal revenue curve of the price leader corresponding to his demand curve dl. AC and MC are his corresponding to his demand curve dl. AC and MC are his average and marginal costs curves respectively.average and marginal costs curves respectively.

the dominant price leader will maximise his profits by the dominant price leader will maximise his profits by producing output OQ and setting price OP. producing output OQ and setting price OP.

The small firms will together produce PB and the price leader The small firms will together produce PB and the price leader BS equals to PH in panel (b)BS equals to PH in panel (b)

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Sweezy assumes that if oligopolistic firm lowers the price, its Sweezy assumes that if oligopolistic firm lowers the price, its rivals will react by price cut in order to avoid losing their rivals will react by price cut in order to avoid losing their customers.customers.

Thus the firm lowering the price will not be able to increase its Thus the firm lowering the price will not be able to increase its demand much. This portion its demand curve is relatively demand much. This portion its demand curve is relatively inelastic.inelastic.

If an oligopolistic firm increases its price, its rival will not If an oligopolistic firm increases its price, its rival will not follow and change their prices. Thus, quantity demanded of follow and change their prices. Thus, quantity demanded of this firm will fall considerably. This portion of the demand this firm will fall considerably. This portion of the demand curve is relatively elastic.curve is relatively elastic.

Thus the demand curve has a kink at the prevailing market Thus the demand curve has a kink at the prevailing market price which explains price rigidity.price which explains price rigidity.

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Non collusive model : The Kinked Demand Curve Non collusive model : The Kinked Demand Curve

The Kinked Demand Curve Hypothesis was put forward by Paul The Kinked Demand Curve Hypothesis was put forward by Paul M. Sweezy & by Hall & Hitch.M. Sweezy & by Hall & Hitch.

K

P

A

B

R

MR

D

quantity

PRICe

b

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D

K1

P0

Sweezy has tried to show that price and output once determined Sweezy has tried to show that price and output once determined under oligopolistic conditions, tend to stabilize rather than under oligopolistic conditions, tend to stabilize rather than fluctuating.fluctuating.

It does not deals with the price and output determination . It does not deals with the price and output determination . Rather seeks to explain that once output is determined an Rather seeks to explain that once output is determined an oligopoly firm does not seeks to change the price even if cost oligopoly firm does not seeks to change the price even if cost conditions undergo a change.conditions undergo a change.

The logic is if it reduces the price other firms will use price cut The logic is if it reduces the price other firms will use price cut policy and if it tries to increase the price other firms might policy and if it tries to increase the price other firms might continue to sell at the same lower price or might lower the prices continue to sell at the same lower price or might lower the prices further.further.

Therefore ,it is desirable to maintain the price to the existing Therefore ,it is desirable to maintain the price to the existing level. level.

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Assumptions Assumptions

1.1. There are few firms in the oligopolistic marketThere are few firms in the oligopolistic market

2.2. Product produced by one firm is the close substitute of the otherProduct produced by one firm is the close substitute of the other

3.3. There is no product differentiationThere is no product differentiation

4.4. There are no advertising expendituresThere are no advertising expenditures

5.5. There is an established or prevailing market price for the productThere is an established or prevailing market price for the product

6.6. Each sellers attitude depends on the attitude of its rivalEach sellers attitude depends on the attitude of its rival

7.7. Any attempt on the part of seller to push up his sales by reducing Any attempt on the part of seller to push up his sales by reducing the price will be counteracted by other sellers who will follow his the price will be counteracted by other sellers who will follow his movemove

8.8. If he raises price, others will not follow him. Rater they will stick to If he raises price, others will not follow him. Rater they will stick to the prevailing price and cater to the coustomers,leaving the price the prevailing price and cater to the coustomers,leaving the price rise sellerrise seller

9.9. The MC cost curve passes through the dotted portion of the The MC cost curve passes through the dotted portion of the marginal revenue curve so that the changes in marginal cost do not marginal revenue curve so that the changes in marginal cost do not effect output and price. effect output and price.

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In the figure KPD is the kinked demand curve and OP0 is the In the figure KPD is the kinked demand curve and OP0 is the prevailing market price for OR product of one seller.prevailing market price for OR product of one seller.

Starting from point P to corresponding price P0 any increase in price Starting from point P to corresponding price P0 any increase in price above it will considerably reduce his sales , for his rivals are not above it will considerably reduce his sales , for his rivals are not expected to follow his price increase.expected to follow his price increase.

This is so because the KP portion of the kinked demand cure is This is so because the KP portion of the kinked demand cure is elastic and mr is positiveelastic and mr is positive

Any price increase will not only reduce his tolal sales but also his Any price increase will not only reduce his tolal sales but also his profits.profits.

If the seller reduces the price of product below OP0his rivals will also If the seller reduces the price of product below OP0his rivals will also reduce their prices.reduce their prices.

Though he will increase his sales, his profits will be less than before . Though he will increase his sales, his profits will be less than before . The PD portion of demand curve below P is less elastic and the The PD portion of demand curve below P is less elastic and the corresponding part of MR curve below R is negative.corresponding part of MR curve below R is negative.

Thus seller has to stick. to the same price which is also termed as Thus seller has to stick. to the same price which is also termed as price rigidityprice rigidity

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