Oligopolies

Oligopoly: a situation in which a particular market is controlled by a small group of firms. 

Product may be homogeneous (eg steel, cement) = pure/homogeneous oligopoly.

Mostly heterogeneous (eg motorcars, cigarettes, household appliances, electronic equipment, etc). = differentiated oligopoly.

Example of an Oligopolistic Market

Key Features of Oligopolies

1. High degree of interdependence between firms.Interdependence: degree to which actions of one firm affect actions of other firms. Each oligopolist always considers how rivals will react.

 2. Uncertainty

Uncertainty over policies of competitors. 

3. Barriers to entry Ranges from free to restricted.

Strategy

Oligopolistic firms must always consider impact of decisions on decisions of its rivals.  

They have two possible strategies: They can join forces & act like a monopolist

(collusion). They can compete to gain a larger share of

industry profits (the competition option). This can be price or non-price competition.

CollusionCollusion: entering into an agreement to limit competition in the industry and maintain high levels of profitability in the long run.

Charge the same prices for certain products Grant uniform discounts, Limit marketing/distribution to certain regions.

Cartel: specific arrangement among otherwise competitive firms to limit output, to set prices, or to share the market, is called a cartel.  Successful collusion is highly unlikely with large numbers firms. 

Conditions for successful collusion

Small number of firms well known to each other.

Similar production methods & average costs – gives incentive to change prices at the same time by the same percentage.

Homogenous product to agree on price Significant barriers to entry. Stable market. No gov.. measures to prohibit collusion.

Most often non-price competition as it drives down industry profit.

Competition

The kinked demand curve Price

Quantity

D = elastic

D = Inelastic

R5

100

Kinked D Curve

The principle of the kinked demand curve rests on the principle that:

a. If a firm raises its price, its rivals will not follow suit

b. If a firm lowers its price, its rivals will all do the same

Assume the firm is charging a price of R5 and producing an output of 100.

If they charge above R5 rivals would not follow suit - elastic demand (substitutes available) – revenue will decrease.

Original Revenue

NewRevenue

If they lower price, rivals will follow suit. % change Q < % reduction in P–inelastic demand curve – revenue will decrease.

New Revenue

Original Revenue

The firm faces a ‘kinked demand curve’ forcing stable pricing structure. May be overcome by non-price competition.

MR & the Kinked demand Curve D = AR

MR cuts ½ between AR & price axis. Kinked demand curve gives rise to:

MR (corresponding to Da) mr (corresponding to ad).

Profit maximised at MR = MC. MC passes through gap between MR & mr

Profit is thus maximised at the existing quantity and price (Q1 and P1).

MC can increase/decrease between R & m without affecting profit maximising point

Advertising as a barrier to entry

Creating product awareness/loyalty can make it expensive for rivals to enter the market.

 

Product diversification as a barrier to entry

Who owns all of these brands???

UNILEVER!!!