MODULE 5: OLIGOPOLY

Oligopoly For a Market to be Described as For a Market to be Described as

Oligopolistic, it must satisfy the following Oligopolistic, it must satisfy the following conditions:conditions:– Few SellersFew Sellers– Mutual InterdependenceMutual Interdependence– The Firm’s products may be identical The Firm’s products may be identical

((Homogeneous) or Differentiated. Homogeneous) or Differentiated. – High Barriers to Entry (as well exit)High Barriers to Entry (as well exit)– Price & non-price competitionPrice & non-price competition

Where Does Oligopoly “fit in?”

Perfect Competition MonopolyPerfect Competition Monopoly

MonopolisticCompetition

Oligopoly

Oligopoly Model OligopolyOligopoly is a market in which a is a market in which a small small

number of firmsnumber of firms supply the entire supply the entire market and where market and where barriers to entrybarriers to entry prevent other firms from enteringprevent other firms from entering

Examples: FMCG, automobiles, Examples: FMCG, automobiles, telecom, air services, steel, cement, telecom, air services, steel, cement, petroleum, etc...petroleum, etc...

- Overt Collusion- Overt CollusionOPEC CartelOPEC Cartel

- Covert Collusion- Covert Collusion- Tacit Collusion- Tacit Collusion

• Price LeadershipPrice Leadership

Oligopolies and CollusionOligopolies and Collusion

Models of OligopolyNo Standard Model due to...No Standard Model due to...

- Diverse behaviour of firms- Diverse behaviour of firms- Interdependence- Interdependence

•Cournot’s duopoly model Cournot’s duopoly model •Sweezy’s Kinked Demand Curve modelSweezy’s Kinked Demand Curve model•Price Leadership modelsPrice Leadership models•Collusive model (the cartel)Collusive model (the cartel)

Each Oligopolist believes that if it raises Each Oligopolist believes that if it raises its price, its price, other firms will keep their other firms will keep their prices constant,prices constant, so the so the quantity quantity demanded will fall by a large amountdemanded will fall by a large amount (demand is elastic).(demand is elastic).

Each firm also believes that if it cuts its Each firm also believes that if it cuts its price, price, other firms will cut their prices other firms will cut their prices too,too, so the so the quantity demanded will rise quantity demanded will rise by a small amountby a small amount (demand is inelastic).(demand is inelastic).

Kinked Demand CurveKinked Demand Curve

PP

QQDD11

DD22

QuantityQuantity

Effectively Effectively creatingcreatinga kinked a kinked demand curvedemand curveThis is an This is an attempt to attempt to explain the explain the “sticky “sticky prices”prices” in in oligopoly oligopoly industries.industries.

Kinked Demand CurveKinked Demand Curve

P

The Kinked Demand Curve Theory

The current The current price is price is PP

And at this And at this price, the firm price, the firm is selling the is selling the quantity quantity QQ

P

The Kinked Demand Curve Theory The marginal revenue curve The marginal revenue curve

from “from “b”b” down. down. The marginal revenue curve

for a price increase runs from “a” up.

The Kinked Demand Curve Theory• Between Between aa and and bb, , there is no marginal there is no marginal revenue curverevenue curve• Cost can increase Cost can increase considerablyconsiderably without without causing the firm to causing the firm to increase price.increase price.• So long as the MC curve passes through the break in the MR curve, the firms keeps its price and quantity constant.

The Kinked Demand Curve Theory Summary:Summary:

– The demand curve has a kink at the current The demand curve has a kink at the current priceprice

– The marginal revenue curve is discontinuousThe marginal revenue curve is discontinuous– Price is sticky and remains at the kink point Price is sticky and remains at the kink point

unless a large enough change in marginal unless a large enough change in marginal cost occurs cost occurs

– The elasticity of demand indicates a The elasticity of demand indicates a decrease in TR for decrease in TR for anyany price change. price change.