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Q.1 Explain Oligopoly Market Structure and explain
Kinked demand curve and Collusion
A market is a group of economic agents (individuals and/or
firms) that interact with each other in a buyer-seller
Oligopoly Market Structure:
A market structure characterized by competition among a
small number of large firms that have market power, but that
must take their rivals actions into consideration when
developing their competitive strategies

Features of Oligopoly
Few Sellers
There are few sellers supplying either homogenous
products or differentiated products.
Homogenous or Differentiated
The oligopoly firm may be selling a homogenous product.
Example: Steel/Aluminium/Copper.
Blockaded entry and exit
Firms in the oligopoly market face strong restrictions on
entry and exit.

Kinked Demand Curve

According to Paul Sweezy, firms in an oligopolistic market
have a kinked demand curve for their products.
Kinked Demand Curve
According to Kinked Demand curve hypothesis, the
demand curve facing an oligopolist has a kink at the
prevailing price level because segment of demand curve
above the prevailing price is highly elastic and segment
below price level is inelastic
Each Oligopolist believes that if he lowers the price
below the prevailing price level his competitors will follow
him and accordingly lower their prices whereas if he
raises the price above prevailing price, his competitors
will not follow his price increase
Discontinuous Marginal Revenue Curve

Oligopoly Price Rigidity

It is observed that quite often in oligopolistic market, once a general
price level is reached whether by collusion or by price leadership or
through some other formal agreement, it tends to remain unchanged
over a period of time. This price rigidity is on account of conditions of
price interdependence explained by kinky demand curve. Discontinuity
of the oligopoly firms marginal revenue curve at the point of
equilibrium price, the price output combination at the kink tends to

remain unchanged even though marginal cost may change as shown in


P1 = Product Price of the Oligopoly

If a firm raises its price (D1), but the others do not match
the increase, then revenue will decline in spite of the price

If the firm lowers its price (D2), then the other firms will
match the decrease to avoid losing market share.

Because there is a kink in the demand curve, there is a gap

in the marginal revenue curve (MR1 -MR2). Since firms
maximize profit by producing that quantity where marginal
cost equals marginal revenue, the firms will not change the
price of their product as long as the marginal cost is
betweenMC1 and MC2, which explains why oligopolistic firms
change prices less frequently than firms operating under other
market models.


Price leadership models ( Tacit collusion)

Price leadership by low cost firm
Price leadership by dominant firm
Price leadership by barometric firm
Collusive Model: Cartel Arrangement

Price leadership model (Tacit collusion)

Tacit collusion arises when firms act together, called acting in
concert, but where there is no formal or even informal
agreement. For example, it may be accepted that a particular
firm is the price leader in an industry, and other firms simply
follow the lead of this firm. All firms may understand this, but
no agreement or record exists to prove it. If firms do collude, and
their behavior can be proven to result in reduced competition,
they are likely to be subject to regulation. In many cases, tacit
collusion is difficult or impossible to prove, though regulators are
becoming increasingly sophisticated in developing new methods
of detection.

Cartel Arrangement:
A cartel is an agreement of cooperation formed between
competitors in a specific industry. A cartel will get together to set
prices and control levels of production with the aim of gaining
mutual benefit. Cartels are made up of companies in the same
industry that traditionally compete against each other, but who
have realized that it is mutually profitable for all players in the
marketplace to work in cooperation to control market conditions.
Members of a cartel will restrict levels of production and output
thereby creating high demand for the product and pushing prices
higher beyond the equilibrium prices.