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Oligopoly

Adajar, Esron Joseph Briones, Lorielyn M. Ortilano Rochele- Ann

September, 2012

L3A

Oligopoly Definition A market structure characterized by a small numbers of firms whose behavior is interdependent.

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An industry with just few sellers.

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Oligopoly is the prevalent type of industrial competition in the United States as well in the most noncommunist industrial West.

Barriers in Oligopoly

Economies of Scale

Perhaps the most significant barrier to entry is economic of scale. Recall that the minimum efficient scale is the lowest rate of output at which the firm takes full advantage of economic scale. If a firm’s minimum efficient scale is relatively large compared to industry output, then only a few firms are needed to produce the total output demanded in market.

High Cost Entry

Oligopoly Model Collusion An agreement among firms in the industry to divide the market up and fix the price. Colluding firms when compared to competing firms, usually reduced output, increased price and block the entry of new firm . Cartel Is a group of firms that agree to collude so that they can act as a single monopolist and earn monopoly profits. Cartels are more likely when the good supplied is homogeneous, as with oil or steel. A cartel provides benefits to member firmsgreater certainty about the behavior of “competitors”, an organized effort to block new entry, and , as a result, increased profit.

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The conditions that give rise to an oligopolistic market are also conducive to the formation of a cartel; in particular, cartels tend to arise in markets where there are few firms and each firm has a significant share of the market. In the U.S., cartels are illegal; however, internationally, there are no restrictions on cartel formation. The organization of petroleum-exporting countries (OPEC) is perhaps the best-known example of an international cartel; OPEC members meet regularly to decide how much oil each member of the cartel will be allowed to produces. (http://www.cliffsnotes.com/study_guide/Cartel-Theory-of-oligopoly.topicArticleId9789, articleId-9779.html)

Figure 1

Price Leadership a dominant firm or a few firms establish the market price, and other firms in the industry follow that lead, thereby avoiding price competition. Price Leader, who set the price for the rest of the industry. The price leader also initiates any change in the price, and others follow.

Kinked Demand Curve Describe the oligopolist’s pricing strategy.

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Demand curve that illustrates price stickiness: if one firm cuts its price, other firms in the industry will cut theirs as well, but if the firm raises its prices, other firm will not change theirs.

Summary of Oligopoly Model

Each of the oligopoly models we have considered helps explain certain phenomena observed in oligopolistic markets. The Cartel, or Collusion, model shows why oligopolists might want to cooperate to determine market price and output: that model also explains why cartels are hard to establish and maintain. Price Leadership model explains why and how firms may act in unison on prices without actually establishing a formal cartel. The Kinked Demand Curve explains why some oligopoly prices tend to remain unchanged for long periods even while costs are changing.

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