Oligopoly

Characteristics of an oligopoly

  1. Homogenous or Differentiated Products

  2. Firms are mutually interdependent - Each must consider possible reactions of its rivals to price, advertising, and development

  3. Concentration ratios are used to measure the structure of an industry.  They are a percentage of the total industry sales accounted for by the four largest firms.  When the largest four firms control 40% or more of the total market, that industry is considered oligopolistic.

  4. The barriers to entry are similar to those in pure monopoly

 

Oligopoly Behavior

  • Mutual Interdependence

    • Each firm's profits depend not only on its own pricing strategy, but also on that of its rivals

    • Oligopoly exists when the number of firms in an industry is so small that each must consider the reactions of rivals in formulating its price policy

  • Collusive Tendencies

    • Collusion is formal or informal arrangements to coordinate pricing strategies

 

There is much incentive to cheat in an oligopoly

 

Kinked Demand: Noncollusive Oligopoly

This is one type of oligopoly model

 

Competitor strategy

  • Price declines by firm A are matched by firms B and C

  • Price increases by A are ignored by B and C

Graphical Portrayal

  • Demand curve to be kinked

  • Marginal revenue curve has a vertical segment

 

This kinked demand curve causes price inflexibility

  • If a firm raises the price, it loses (others will ignore the increase)

  • If a firm decreases price, sales rise very modestly (because others will match the price)

  • A price cut may start a price war, so a firm's sales may actually decline if prices decreases

  • The broken marginal revenue curve accompanying demand curve suggests that substantial changes in marginal cost will have no effect on output and price.

 

Oligopoly and Economic Efficiency

  • Allocative and Productive Efficiency is almost never obtained  

 


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