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What Is Oligopoly?

It is a form of market organization in which there are few sellers of a homogeneous or differentiated products. If there are only two sellers then it is a duopoly If the product is homogeneous, then it is pure oligopoly and if differentiated then it is differentiated oligopoly It is most prevalent form of market organization in the manufacturing sectors of industrial nations. Although entry into oligopolistic industry is possible but it is not easy Example: Nepal Telecom & N-cell in telecommunication, cement producers in Nepal, Domestic airline in Nepal, cold drinks

Cont..
Since there are only a few firms selling a homogeneous or differentiated product in the oligopolistic markets, the action of each firm affects the other firms in the industry Oligopolist prefer to compete on the basis of product differentiation, advertising, and service non price competition The most distinguising feature of oligopolist firm is the interdependence or rivalry among the firms in the industry as a result of fewness They need to consider possible reaction of competitors while deciding its pricing policies, the degree of product differentiation to introduce, the level of advertising to undertake, the amount of service to provide.

Factors causing Oligopoly


1. Economy of scale may operate over a sufficiently large range of outputs as to leave only a few firms supplying the entire market 2. Huge capital investments and specialized inputs are usually required to enter an oligopolistic industry (automobiles, aluminium, steel) 3. A few firms may own a patent for the exclusive right to produce a commodity or use a particular production process 4. Established firms have a loyal following of customers based on product quality and service (brands) 5. A few firms may own or control entire supply of a few raw material required in the production 6. Government may give a franchise only to few firms to operate in the market

Features of Oligopoly
1. Small number of firms. There is a small number of firms under oligopoly; the number of sellers is so small that the market share of each firm is large that a single firm can influence the market price and business strategy of rivals 2. Interdependence of decision making. It is the most striking features; fewness of firms brings the firms in keen competition with each other; The competition between the firms takes the form of action, reaction and counteraction in the absence of collusion between the firms. Being small number of firms in the industry, the decisions in respect of pricing, advertising, product modification is closely watched by the rival firms 3. Barriers to entry. Barriers may arise due to market conditions: huge investment requirement, economies of scale enjoyed by existing firms, consumer loyalty, resistance established by price cuts 4. Indeterminate price and output. There is indeterminateness of price and output; In collusive oligopoly price may be determinate but difficulty to predict their collusion

Concentration ratio
The degree by which an industry is dominated by a few firms is measured by concentration ratios It gives the percentage of total industry sales of the 4, 8 or 12 largest firms in the industry An industry in which the four firm concentration ratio is close to 100 is clearly oligopolistic, and the industries in which this ratio is higher than 50 or 60 percent are likely to be oligopolistic

Oligopoly models
The most important oligopolistic models are: the cournots model, the kinked demand curve model, cartel arrangements and the price leadership model

Cournots duopoly model


Introduced by French economist Augustin Cournot It is useful to highlight the interdependence that exists among oligopolistic firms For simplicity he assumed that there are only two firms (duopoly) selling identical spring water. Consumers come to the springs with their own containers marginal cost of production was zero Both firms face a demand curve with constant negative slope Each firm acts on the assumption that its competitor will not act to its decisions to change its output cournots behavior output

Cournot equilibrium
D

P2

P1

Q MR

Initially DM is the demand curve of firm A, producing OQ (1/2 of total market demand) output at price P2. Firm B, enters the market and produces 1/2 of QM, QN at price P1. But now firm A reacts and would produce (1-1/2) = 1/8 of the market demand and again B would react and produce (11/8) Firm A = -1/8-1/32-1/128-. Firm B = +1/16+1/64+. Solving for both we get 1/3 as the optimum quantity produced
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The Kinked Demand Curve Model


It was introduced by Paul Sweezy in 1939.

He postulated that if an oligopolist raised its price, it would lose most of its customers because other firms in the industry would not follow by raising their prices. On the other hand an oligopolist could not increse its share of market by lowering its prices because its competitors would quickly match price cuts.
As a result according to Sweezy oligopolists face a demand curve that has a kink at the prevailing price and is highly elastic for price increases but much less elastic for price cuts.

The firm believes that the demand for its product has a kink at the current price and quantity. Above the kink, demand is relatively elastic because all other firms prices remain unchanged. Below the kink, demand is relatively inelastic because all other firms prices change in line with the price of the firm shown in the figure.

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The kink in the demand curve means that the MR curve is discontinuous at the current quantity shown by that gap AB in the figure.

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Fluctuations in MC that remain within the discontinuous portion of the MR curve leave the profitmaximizing quantity and price unchanged. For example, if costs increased so that the MC curve shifted upward from MC0 to MC1, the profitmaximizing price and quantity would not change.

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The beliefs that generate the kinked demand curve are not always correct and firms can figure out this fact. If MC increases enough, all firms raise their prices and the kink vanishes. A firm that bases its actions on wrong beliefs doesnt maximize profit.

Dominant Firm Oligopoly


In a dominant firm oligopoly, there is one large firm that has a significant cost advantage over many other, smaller competing firms. The large firm operates as a monopoly, setting its price and output to maximize its profit. The small firms act as perfect competitors, taking as given the market price set by the dominant firm.

Figure shows10 small firms in part (a). The demand curve, D, is the market demand and the supply curve S10 is the supply of the 10 small firms. At a price of $1.50, the 10 small firms produce the quantity demanded. At this price, the large firm would sell nothing. But if the price was $1.00, the 10 small firms would supply only half the market, leaving the rest to the large firm. The profit-maximizing quantity for the large firm is 10 units. The price charged is $1.00.

Collusive Oligopoly
Suppose that the two firms enter into a collusive agreement. A collusive agreement is an agreement between two (or more) firms to restrict output, raise the price, and increase profits. Such agreements are illegal and are undertaken in secret. Firms in a collusive agreement operate a cartel.