Price and Output Determination Under Oligopoly

An oligopoly exists between two extreme market structures, perfect competition, and monopoly. When
a few firms dominate the market for a good or service is called oligopoly. This implies that when there
are few competing firms, their marketing decisions reveal strong mutual interdependence. Here mutual
interdependence means that a firm’s action says of setting the price has a noticeable effect on its rival
firms and they are likely to react in the same way. Each firm appraises the possible reaction of rivals to
its price and product development decisions. Let us now study Price and Output Determination Under
Oligopoly.

Oligopoly Definition

“Oligopoly is an industry structure characterized by a small number of firms producing all or most of the
output of some good that may or may not be differentiated”.

Price and Output Determination Under Oligopoly

Cournot’s Model

Stackelberg Model

Bertrand Model

Edgeworth Model

Collusive Oligopoly

Cournot’s Model

As per Cournot’s model, each duopolist thinks that regardless of his actions and the effect upon the
market of the product the other will go on producing the same commodity.

Cournot model says if the output of a firm is two- thirds of the competitive output and the price is two –
third, this is most profitable i.e., monopoly price.

Stackelberg Model

The producer under a duopoly structure integrates the decision level of his rival. It then integrates in its
own profit function and thereby maximizes profit. Thus, Leader-follower relation emerges.

Bertrand Model

According to this model, producers try to set lower the price until the price is equal to the cost of
production.
Edgeworth Model

Each duopolist thinks that his rival will continue to charge the same price as he is just doing irrespective
of what price he decided to set. No determinate equilibrium will exist under duopoly.

Learn more about Pricing in Imperfect Competition here in detail

Collusive Oligopoly

According to this model, firms form a cartel. Firms jointly fix the price and output with a view to
maximizing joint profit. For example, OPEC countries form a cartel.

Price and output determination under oligopoly

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Explanation of Price and Output Determination Under Oligopoly

We can not explain the pricing and output decisions under duopoly a single theory. It will not be
satisfactory. The reasons are:

(i) The number of firms may vary which is dominating the market. Sometimes there may be
only two or three firms that dominate the entire market (Tight oligopoly). At another time
there are 7 to 10 firms that capture 80% of the market (loose oligopoly).

(ii) The goods produced may or may not be standardized under oligopoly.

(iii) Sometimes the firms under oligopoly cooperate with each other in the fixing of price and
output of goods. At another time, they choose to act independently.

(iv) Sometimes barriers to entry are very strong in oligopoly and at another time, they are quite
loose.
 (v) Sometimes A firm under oligopoly cannot certainly predict with the reaction of the rival
firms if any changes occur in the prices and output of its goods. Considering the wide range
of diversity of market situations, a number of models have been developed which explain
the behaviour of the oligopolistic firms.

Example on Price and Output Determination Under Oligopoly

What are the main characteristics of oligopoly?

Solution:

Characteristics of Oligopoly

The main characteristics of oligopoly are:

(i) The small number of firms: Oligopoly is a market where a small number of firms exist. These
firms dominate the industry to set prices.

(ii) Interdependence: In an oligopolistic market structure all firms in an industry are mostly
interdependent. The leading firm takes actions with respect to output, quality product
differentiation can cause a reaction on the part of other firms.

(iii) Realization of profit: In an oligopolistic market structure firms are often thought to realize
economic profits. In the case of profits, there is an incentive for the entry of new firms. The
existing firms then try to block the entry of new firms into the industry.

(iv) Strategic game: The entrepreneurs of the firms are like generals in a war In an oligopolistic
market structure. They try to predict the reactions of rival firms. It is a strategy game which
they play in capturing the market.