OLIGOPOLY

Definition
▪ Market structure in which there are only a few firms selling
either standardized or differentiated products and it
restricts the entry into and exit from the market.
Characteristics
 Few numbers of firms – the number of firms is small but
size of the firms is large.
 Homogeneous or differentiated product
 Mutual interdependence – firms in an oligopoly market
always consider the reaction of their rivals when choosing
price, sales target, advertising budgets and other business
policies.
 OLIGOPOLY (cont.)

 Barriers to entry – restrict new entrants into the

market through various types of barriers to entry such
as control of certain resources, ownership of patent
and copyright, exclusive financial requirements and
other legal barriers.
 OLIGOPOLY (cont.)

Price Rigidity and Kinked Demand Curve

▪ Since there is mutual interdependence between oligopoly firms, the
prices in the market are more stable. This is called price rigidity in
oligopoly market.
▪ The price rigidity explains the behaviour of an oligopoly firm that has
no incentive to increase or decrease the price. The theory of the
kinked demand curve is based on two assumptions.

1. First assumption: If an oligopolist reduces its price, its rivals will

follow and cut their prices to prevent losing the customers.
2. Second assumption: If an oligopolist increases its price, its rivals
do not increase the price and keep their prices the same, thereby
they gain customers from the firm that increases the price.
 OLIGOPOLY (cont.)

Because of this According to the assumption, An oligopoly firm faces

assumption, an when the firm increases the two demand curve,
oligopolist faces kinked price (P*), no other firms will individual demand
Price (RM) demand curve. follow. Above P*, the firm will curve (dd) and industry
follow the dd curve. demand curve (DD).
If the firm decreases the price,
other firms will follow. Below
P*, the firm follow the DD
curve.

P*

dd

DD

Q*
Quantity
 OLIGOPOLY (cont.)

This shows the price rigidity
in the oligopoly market.
Price (RM)
At this range of MR, any
change in the MC does not
reflect changes in the profit
maximizing price and output.
The kinked demand
curve below Point E
creates a gap in the
MR, which is indicated
by the dotted line ab.

MC1
MC2
E
P*

b DD

Q*
MR Quantity
 OLIGOPOLY (cont.)

Price Leadership
▪ Price leadership means the pricing strategy in which the
firms in an oligopolistic industry follow the price set by the
leading firm.
▪ Price leadership is one form of collusion under oligopoly.
▪ There is no formal or tacit agreement.
▪ There are two types of price leadership:
1. Dominant price leadership
➢ The dominant price leadership firm may be the largest
firm that dominates the overall industry.
➢ The dominant price leader firm can act as a monopoly
where it sets its price to maximize profits; other firms
will set their prices at the same level.
 OLIGOPOLY (cont.)

2. Barometric price leadership

➢ One firm will be the first to announce price change.
This firm does not dominate the industry.
➢ Its price will be followed by others.
 OLIGOPOLY (cont.)

Cartel
 A cartel is a group of firms whose objective is to limit the
scope of competitiveness in the market.
 Cartel arises because firms want to eliminate uncertainty
and improve profits by stabilizing market shares and
prices, reducing competitiveness and eliminating
promotional cost.
 The most famous cartel is Organization of Petroleum
Exporting Countries (OPEC).
 Cartel agreement is an arrangement among the
oligopoly firms to cooperate with one another to act
together as a monopoly.
 OLIGOPOLY (cont.)

 An ideal cartel will be powerful to establish monopoly

price and earns supernormal profits.
 Profits are divided among firms based on their individual
level of production.
 Each firm sells at different quantities and obtains different
profits depending on the level of AC at the point of
production.
 OLIGOPOLY (cont.)

Non-Price Competition
 Non-price competition is the means for growing market
share and profitability in the face of new rivals through
advertising, marketing, after sales service, free gift and
others.
 The difference with price cuts by oligopoly firm and non-
price competition.
▪ Opting for price cut – If a firm reduces a price of a product, it can
attract customers, and establish in the industry.
Reactions of competitors – the reaction from rivals are quick by
reducing their prices. There is a risk of price war if the price reduction
continues. However, customers are better off.
 OLIGOPOLY (cont.)

▪ Opting for non-price competition – This strategy will attract more

customers to the firm.
Reactions of competitors – the reaction from rivals toward non-price
competition is slow and less direct. The firms will gain more
advantages if it practices non-price competition because product
variation, improvements in quality and successful advertising
techniques cannot be duplicated so easily. Some consumers are
more attracted to the advertisement and quality of the product
compared to price.
 Reference

Deviga Vengedasalam, Karunagaran

Madhavan., (2007) Principles of Economics.
Kuala Lumpur: Oxford Fajar.