Oligopoly

Oligopoly
• It is a market form in which there are few sellers
of homogenous or differentiated products
• If the commodity is homogenous then its is pure
Oligopoly and if differentiated product then
differentiated Oligopoly
• Oligopoly model fits well into industries such as
Automobile, Manufacturing of Electrical
Appliances etc.
 Features of Oligopoly
• Few Sellers

• Homogeneous / Distinctive Product

• Blocked Entry and Exit

• Interdependence

• Uncertainty
• Remain independent in decision making

• Maximize profits – interdependence of pricing policies

• Indeterminateness
 Collusive & Non Collusive
Oligopoly
• Firms tend to invest heavily in new machinery
& processes to try & reduce their cost & make
more profit

• Expenses are high as they try to differentiate

their products from competitors

• Firms in non – collusive oligopoly use

advertising & mktg to compete
 Collusive & Non Collusive
Oligopoly
• Collusion
• It occurs when firms work together to reduce
uncertainty in market – involves price fixing,
control over supply, wage fixing etc.
• To control supply, market should be dominated
by large firms, demand should be inelastic
• Dominant firm can take the role of price leader,
setting the price for the market
 Collusive
Oligopoly Non Collusive

• Firms decide to collude • Firms do not collude but

& avid competition compete with each

• Firms behave like other

single monopoly & aim • Firms aim at

at maximizing collective maximizing its own
profit rather than profit & decides how
individual profits much to produce
 Price Stickiness / Rigidity
• Theory of Oligopoly states that once a price has been determined
it will stick to it
• This is because firms cannot pursue independent strategies
• If 1 airline decides to increase its fair rivals may not necessarily
increase the price and the firm may lose its revenue
• Rivals have no requirement to follow the suit as it will be their
competitive edge to keep the same prices
• DD for price is relatively elastic
• However, if 1 airline lowers the price then other firms are forced to
do so
Kinked Demand
Curve
 Y Y

D
D
D

Price
T T
Price

Da
Db Db
O O
X M X
Quality
Quality
 Kinked Demand curve
• Due to dependency and uncertainty a sp e ct, oligopoly le a ds to
inde te rminate ne s s of de ma nd curve

• We ha ve ta ke n a n e xa mple of ltd oligopoly i.e . only 2 firms

• There are 2 demand curve s in the diagram. DDa of firm A and DDb of
firm B. DDa is e la s tic and DDb is le s s e la s tic.

• DD curve s inters e ct at point T

• AT point T the re is a kink

• The TD part of demand curve is more ela stic and the TDb part is
inela s tic

• Kinky Demand Curve is obtained by taking TD part from A and TDb part
of firm B

• At price OP, quantity OM is sold. Price OP is expected to rem ain

 Kinked Demand Curve
• @ Pric e OP, OM qua ntity is s old – Pric e OP is
e xpe cte d to re ma in cons ta nt due to price rig idity

• Reduction in Price – if price is re duce d from OP

to ca pture more s a le s , riva l firms will a ls o follow
the purs uit

• Howe ve r, g a in of e a c h firm will be ma rg ina l

he nce cha ng e in price be low OP ma ke s TDb pa rt
le s s e la s tic
 Kinked Demand Curve
• Incre as e in Price
• If s e lle r incre a s e s the price a bove OP the n he
ma y loos e his c us tome rs a s riva l firms ma y not
incre a s e the pric e
• A s ubs ta ntia l de cre a s e in de ma nd for a n
incre a s e in price a bove OP ma ke s DT pa rt of DD
curve more e la s tic
• He nc e DT pa rt is more e la s tic tha n DTb
 Kinked Demand Curve
• Rig id Price
• Price charg ed in oligopoly mkt is exp ected to cov er full co st
&ha ve e xc e s s profits
• Thus price charg ed by them remain con stant without
cha ng e s
• A cha ng e in price ma y come collective ly
• F e ar of losing mkt if price is increa s ed or not g aining much
if price is decre a s ed make s oligopoly firm to stick to the
price initially cha rg e d
• DD curve at point of price ha s a kink, hence DD curve is
 Collusive Oligopoly – Cartel
Formation
• Existing s ellers form an a gre ement on jointly
controlling ma rke t s upply a nd de te rmining the price s
• It is le g a lly binding a nd known to a ll
• Cartel Formation is a type of Collusion but an explicit
one
• Cartels are formed to enjoy monopoly power.
Howev er, it can s ometime s be more harmful than
monopoly
• Monopoly can create harm to consumer s only if he
 Price Leadership
• Domina nt Firm Le a de rs hip

• Low Cos t Firm Le a de rs hip

• Ag g re s s ive price Le a de rs hip

• Ba rome tric Pric e Le a de rs hip – old, e xpe rie nce d

& re s pe cte d firm ta ke s up the le a de rs hip role – it
is e xpe cte d to unde rs ta nd mkt, de cide the price s
on the ba s is of de ma nd, cos t of prodn,
c ompe tition e tc .
Limitations of Price Leadership
• Non – P ric e Compe tition

• P roduc t Diffe re ntia tion

• Diffe re nc e in P roduc tion Cos t