https://www.youtube.com/watch?

v=ZH7w7pyXC9I Key Points of Oligopoly

Oligopoly
 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.
• Entry is not restricted but difficult due to requirement of
investments/economies of scale/consumer loyalty
• 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.
• Duopoly is that type of oligopoly in which only two players operate
(or dominate) in the market.
 Features of Oligopoly

• Non Price Competition: Firms are continuously watching

their rivals, each of them avoids the incidence of a price
war.
• 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
P1 retorts by lowering the price below
that of A.
• A further reduces the price and this
process continues, till the firms reach
A P2 B P2.
• Both realize that this price war is not
Market share O Market share helping either of them and decide to
end the war. Price stabilises at P2.
of A of B
 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.
– 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 increase not followed by rivals and less elastic demand in
case of price decrease which is followed by rivals.
• 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.
 Features of Oligopoly
• Indeterminate Demand Curve
• Price and output determination is
very complex as each firm faces
Pric D1 two demand curves.
e • Demand is not only affected by its
D own price or advertisement or
quality, but is also affected by the
price of rival products, their quality,
packaging, promotion and
placement.
D • When the firm increases the price it
D1
faces highly elastic demand (DD);
when it reduces the price it faces
O Quant inelastic demand (D1D1)
ity
 Kinked Demand Curve
(price and output determination)
Price,
Revenue, D1
Cost • Discontinuity in AR (D1KD2)
K
MC1 creates discontinuity in the MR
P MC2 curve.
A
• MR is constant between point A
and B.
S
T
D2 • Producer will produce OQ,
B
whether it is operating on MC1 or
O
Q Quantity
MC2, since the profit maximizing
MR
conditions are being fulfilled at
points S as well as T.
• D1K = highly elastic portion of • If MC fluctuates between A and
the demand curve when rival B, the firm will neither change its
firms do not react to price rise output nor its price.
• KD2 = less elastic portion, • It will change its output and price
when rival firms react with a only if MC moves above A or
price reduction. below B.
• Kink is at point K.
 Collusion Model
Rival firms enter into an agreement in mutual interest to

• A) eliminate uncertainty surrounding the market

• B) restrain competition and thereby ensure monoplistic
gains to the cartel group

• Explicit collusion: When a number of producers (or

sellers) enter into a formal agreement.
• Tacit collusion: A collusion which is not formally
declared.
 Collusion
Cartel
• A formal agreement among firms on price and output.
• Occurs where there are a small number of sellers with
homogeneous product.
• Normally involves agreement on price fixation, total
industry output, market share, allocation of
customers, allocation of territories, establishment of
common sales agencies, division of profits, or any
combination of these.
• Immediate impact is a hike in price and a reduction in
supply.
• Two types:
• centralized cartels
• market sharing cartels.
 Cartel
• A formal agreement among firms on price and output.
• Occurs where there are a small number of sellers with
homogeneous product.
• Normally involves agreement on price fixation, total
industry output, market share, allocation of
customers, allocation of territories, establishment of
common sales agencies, division of profits, or any
combination of these.
• Immediate impact is a hike in price and a reduction in
supply.
• Two types:
• centralized cartels
• market sharing cartels.
 Price Leadership
• Dominant Firm: a leader in terms of market share,
Emerge as a result of :
• Size
• Efficiency
• Ability to forecast market conditions accurately

• Price Leadership by low cost firm :

The largest firm is the low cost firm due to economies of
scale and its cost of production is lower than that of other
firms