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Oligopoly

Assumptions of Oligopoly

Objectives of an Oligopoly other than Maximising Profits

Explanation of a Kinked Demand Curve


P P1 A C

P2

B D1

D2
Q2 Q

Q1

Q3

The firm reduces its price from P1 to P2, quantity demanded will increase from Q1 to Q2. However if competitors react by also reducing their prices, the overall level of Demand for our product will shift inwards from D1 to D2, and instead of our quantity rising to Q2, it will only rise to Q3 and instead of our demand curve being [ACB], because of the reaction of our competitors our demand curve will become [ACDE]. A Kink has come into the demand curve at point C.

Price

Elastic

This Diagram is the Demand Curve in Oligopoly. It is kinked at Point C. Inelastic From C to E in the Diagram the Demand Curve is inelastic. A reduction in Price E will not bring the % increase in sales as expected because other firms will also reduce Quantity their price winning back their customers so overall it will not pay to reduce price.

If the Price is increased above point C in the diagram, other firms will keep their price at C and the % fall in quantity will be far greater than the % rise in price. For these reasons prices will tend to settle at Point C in Oligopoly. The Part of the Diagram A to C will then tend to be Elastic

Kink in Demand Curve & Sticky Prices


The kink in the demand curve helps to explain Price Rigidity. Prices tend to be rigid (Sticky) around point C in the diagram above. If the price is increased Price elasticity will tend to be elastic and the sales will fall off dramatically because competitors will continue to sell at the existing lower price and win customers away from you. The price is reduced, the gains in sales will not be as large as anticipated because competing firms will also have to reduce their price to stay in Business. For the above reasons prices tend to be rigid around point C and even if there is a slight change in cost, prices will not be changed and firms may rely on Non Price Competition.

Examples of Non-Price competition 1. After Sales Service e.g. repairs, spare parts etc. 2. Product Differentiation emphasis on quality e.g. Better petrol consumption in cars, greater safety feature. 3. Advertising/ Promotional Gifts / Demonstrations/Luxurious Surroundings.

AR and MR Curves Under Oligopoly


Price

MR

D = AR MR

Quantity

Demand Curve AR Curve in Oligopoly with a change in COST


Price
MR G MC 2 H MR MC 1 Between G and H any change in Marginal cost will not change the Equilibrium Quantity where MC=MR there prices here tend to be sticky.

D = AR

Quantity
In Oligopoly diagrams because of the Kink in the Demand Curve (AR) there will be a gap in the Marginal Revenue (MR Curve) as shown in the above diagrams. If there is a rise in cost as shown from MC 1 rising to MC 2 it may not be possible to determine where marginal cost is cutting the marginal revenue curve and this is a second reason which explains why prices may be rigid in Oligopoly.

Price Leadership is where one firm dominates the industry and acts as a monopolist and chooses the price/output combination to maximise profits.
A number of smaller firms may have small segments of the market and will take their price from the Price Leader.

Shape of Kinked Demand Curve under Oligopoly

LR Equilibrium of Kinked Demand Curve under Oligopoly

Rigidity of Prices under Kinked Demand Curve under Oligopoly

Collusion In Oligopoly

Baumols Model of Sales Maximisation rather than Profit Maximisation


1. By increasing sales, it might enable the firm to make a breakthrough in economies of scale from large production, leading to the good to be produced much more cheaply. 2. By making sure goods are extensively available, it may make it more difficult for other firms to set up in competition. 3. Sales and Production managers may feel that their careers will improve if they can increase Sales and Output. 4. When MC is less than MR increasing sales means increasing profits
Baumols Model basically said that a business would be happy if it could reach a target level of profits (not maximum) and so long as the target level of profits is achieved , the aim of the firm would be to maximise sales.

Baumols Model of Sales Maximisation subject to achieving a target level of Profit.


Total Revenue

Price
Total Costs

Target profit level Profit

Q1

Q2

Quantity