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16.0 OBJECTIVES
~ f t c studying
r Illis unit yon should bc nblc to:
dcfinc oligopoly and cnlist its cli;~nctcristics
describe various models of oligopoly
esplain why oligopolists try to collude anlongst tliemselvcs rather than cotnpcte
csplain tllc implications of collusion
16.1 INTRODUCTION
In units I4 and 15 you Ili~vclcanit tliiit in th~':ibsc~icc
of pcrfcct compctition wc gct impcr-
fcct colnpctitioli \vllich could takc cillicr tl~cfort11of monopoly or nloilopolislic
compctition. Utidcr monopoly markct condition tlicrc is no ronipctition at all and thcrclorc
tllc sellcr yiclds unqocslioncd polvcr to influence tlic pyicc. Undcr nio~iopolisliccol~lpctitio~~
t l ~ csourcc of impcrrcction is diffcrcntiatcd products prodrlccd by large numbcr of closc
rivals. ~ h c r tlicrcc arc largc numbcr of scllcrs. ciipacity to product difircntialion may gi\.c
cacli scllcr a liltlc powcr to influcncc l l ~ cpricc of his comniodity. Under perfcct compctition
tlic scllcr has no sr~clipowcr at ;III si~icctllcrc is rip scopc for prodr~ctdiffcrc~itiation.In
bct~vccntllcrc is il sitr~iltioli~vhicllis dirfcrc~ltfrom botll monopoly i~ndmonopolistic
compctition and \vlicrc tlicrc arc f c scllcrs
~ ciicli of thcm comni:inding ;I ~~bsti111ti;il
shiirc of
tlic markct. Tiiis situation is callcd oligopoly. Tl~osin oligopoly inipcrfcction rcsults f r o ~ i i ~
~ C \ V I I C S S Ofimls.
~
Types of Oligopoly .
Oligopoly is of two types : (a) discriniinato~oligopoly and (b) pure oligopoly.
Discriminatory Oligopoly: In tlic cnsc of discriminaton oligopoly diffcrcnt prodr~ccrsof
the product scll goods similar to onc nnothcr. Tliough tlic goods produccd by diffcrcnt
producers have sollie distinguished cl~nri~ctcristics. all of tlic~narc closc s~~bslitutcs.
From the
co~isu~iicr's
point of \~iciv.tlic diFfcrcnccs in tlic goods can bc both rcal and imaginary.
Gcncn~llydiffcrcnccs on account orsizc. sli;lpc. quality arid dcsign ctc. arc rc;il \vl~ilc
diffcrcnccs on account of trndc miirk and bc~tidname of tlic goods arc i11iilgin:ln..
Purr: Oligopoly: Ili thc cnsc purc oligopoly. all linns producc idc~tlicalprod~~cts which
aicans tliiit t l ~ producers
c do not indulge in product diffcrc~iti:~tioi~.
Tlicrcforc. cons~~nicr's
dccisions to pi~rcliasctlic good of a partici~lnrprodr~ccrarc inllucnccd by thc pricc
considerations. In otlicr words non-pricc co~npctitioncannot takc placc r~iidcrconditions of
purc oligopoly.
The :idvantage of product differc~itintionis that t h scllcr.
~ cvcn if lic is charging ;I slightly
I~igherpricc than tlic rest. can liopc to rct;li~itlic s;ilnc piirt of tlic m;lrkcl bcc:~i~schis product
is diffcrcnt to sonic cstcnt. In fiict through ad\~crliscmciitsIic 111;lyC\.CII SIICCC,:~ i n crcnling
tlic iniprcssiori that his prodt~ctis superior. Iio\vc\.cr. this liniitcd scopc also docs not csist
wlicrc product diffcrc~itiationis abscnt. 111 purc or pcrfcct oligopoly tlicrc is hardly any nccd
for ndvcrtiscment nnd for incr~rringsclling costs. All 111i1t rcmains is pricc compctition i ~ i d
T h c ~ ~ rofy Price that too ofthc fierccst posSible kind. 111sucli circi~mstanccs.if any produccr nliscs his pricc
he ciln alnlost bc surc of tlic rcaction and onc rcallvdocs not k1101v \vlicrc this war of action
and reaction utill take him. Tllns starting with an initial pricc which may bc nlcll abovc cost
of production, pure oligopoly map, because of pricc war. cnd up with a pricc nlliicli is.just
equal to average cost of production. Under thc conditions of pure oligopol~cquilibrin~n
becomes even more difficult and the market rcmains in the grip of an nnccrtainty \vhich lnay
be greater than that in other types of oligopoly.
f X E Q C V Q ~ ~ d
1) M'W-dallm
*.-rn ..Ir-.'...,
... .......- .....
.,ssa*..Ii ...,.............
r*...... i.r..r...r b......'..., ......................................
Quantity
Figure 16.1 : Kinked Demand curve under Oligopoly
According to the kinky oligopoly demand curve theory, each oligopolist believes that if he
lowers the price below the prevailing level, his competitorswill follow him and if he raises
the price above the prevailing level, his competitors will not follow his price increase.
The above assumption may be explained in detail. In order to increase his sales if the
oligopolist reduces his price below the prevailing price lmel QK, the competitors will fear
that they will loose their customers to the former oligopolist who has cut his price. Therefore.
in order to retain their customers they will be forced quickly to match the price cut. Because
of this quick reaction from the competitors he will gain only little in sales. This means that
the demand for him is inelastic below the prevailing price, QK, showing a very little increase
in sales for a reduction in price by an oligopolist.
On the other hand, if a oligopolist raises his price above the prevailing level, there will be a
substantial reduction in his sales. As a result of a rise in his price, his customers will go to his
competitors who will welcome the new customers and gain in sales. The competitorswill
therefore have no motivation to match the price rise. Thus, the demand for him is highly
elastic above the prevailing level, QK, showing a large fall in sales if an oligopolist raises his
price.
This is how anbligopolist expects his rivals to match his price cuts quickly but does not
expect his rivals to match his price increases. Given this expected competitivereaction
pattern, each oligopolist will have a k i e d demand curve.
l'he kinked demand curve helps to e'uplain why oligopolistic prices tend to be inflexible.
Under the assumptions of the kinked dema6d.curve, a price rise would lead to a sllarp
\&ction in sales. Conversely a price ieductibn would attract few new customers. Thus, once
a price is established, it remains inflexible for estended periods of time. However, the theory
does not explain how the price has been established.
Duopoly Models
A special case of oligopoly called duopoly exists whcn there are only two sellers of a
product. Let us briefly describe some classical models of duopoly.
,164.3 Cartel
Cartel is a formal agrecrnent of the different oligopoly firms. Cartels are the pcrfect form of
collusion. The finnsjoin together not only to fix the price they would charge but also the
share of the market each wo~ildbe entitled to. In this agreement they aim at some kind of
joint profit masimisation. Thus under perfect cartel type of collusive oligopoly, the price
and output determination of the whole in dust^ as well as of each member firn~is dctermined
by the common administrative authority so as to achieve masimi~mjoint profit. -
The main purposc of the organisational am~ngcmcntis to assurc that thcrc is no pricc war and
. that cntry of ncw f i m ~ is
s restricted 11sfar as possiblc. Though a cartel may desire to rcstrict
the entry of other finns into thc markct. it does not I~;IVC lcgal mcans of doing so. Tllc OPEC
(Organisation of Petroleum Exporting Conntries) is ;I cartcl \vhich sccks o fis thc price of oil
and also thc sharing of thc world oil market bet\vcen tllc mcmbcr countries. Howevcr. while
agreeing on price and market sharing may be easy, policing thc iigrccliient can bc difficult.
This is becausc there is an inhercnt tcndency on the pan of thc produccrs to tr). to outwit
other producers in ways which involve infri~~gemcnt of the common arrangcmcnt. Thc main
advantage in a cartel is that the oligopolists retain individual control of thcir production
unit.
It may. however. be noted that cartels do not ncccssarily crcatc thc conditions for pricc
stability in an oligopolistic market. There is no binding on thc nlcnlbcrs undcr carlcl
agreements. Cartels do not prcvent the possibility of cntry of neu firms as there is no lcgnl
provision.
d
.
2) What is a cartel?
.........................
c..r d‘....;.X.r.i... ,...,.
iiiiiiiii .i...u .,.... i;‘.~i~.,iii,..~ii~~..~+ii.~~ii.,....i*...' ............
iii) Oligapolist9 loose individual mntroi of their pmduction unit unda a Cartel
iv) Met I a i a h i p is an uampls:o f d t agreema.
V) M c e-1 b a aafad mm of cellus@ buwmolilppalv firms
Notc: These questions help you to understand the unit better. Try to write
answers for them. But do not send your answers to the University. These are
for your practice'only.