UNIT

Oligopoly Competition

Names of Sub-Units

Meaning of Oligopoly Competition, Types of Oligopoly, Models of Oligopoly, Collusive and Non-Collusive
Model - Sweezy’s Kinked Demand Curve Model and Price Leadership, Cartels.

Overview
In this unit, you study the characteristic features of oligopoly, types of oligopoly and different oligopoly
models. You will also study the non-collusive models, such as kinky demand curve and collusive models
such as centralised cartel and price leadership by dominant firm.

Learning Objectives

In this unit, you will learn to:

 Explain meaning and characteristic features of oligopoly
 Discuss the non-collusive models such as Paul Sweezy’s Kinky Demand Curve
 Describe the collusive models such as centralised cartels and dominant firm price leadership

Learning Outcomes

At the end of this unit, you would:

 Evaluate the meaning and characteristic features of oligopoly
 Analyse the non-collusive models such as Paul Sweezy’s Kinky Demand Curve
 Understand the collusive models such as centralised cartels and dominant firm price leadership
to real world situations such as the cement industry
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Pre-Unit Preparatory Material

 https://www.nr.edu/eco202/author_pps/pdf/econ2_micro_ch10.pdf
 http://www.sajaipuriacollege.in/wp-content/uploads/2020/03/oligopoly-2.pdf
 http://www.econ.jku.at/t3/staff/winterebmer/teaching/managerial/ss21/ManagEc6_2020_rwe.
pdf

12.1 INTRODUCTION
In the real world, perfect competition does not exist. Monopoly is rare. Monopolistic competition is limited
to hyper-local markets such as vegetable markets or fruit sellers. But the big business game belongs to
only oligopolists. Almost every big industry in today’s world, worth its salt, is run by oligopolists. From
footwear to the shipping industry from submarines to spacecraft, all industries are dominated by a few
large firms. And despite regulatory scrutiny, the unholy nexus between businessmen, politicians and
bureaucrats have resulted in cartels surviving and thriving at the cost of the common man. In fact,
oligopoly is the biggest threat to markets today and is resulting in deprivation and impoverishment of
the masses.

12.2 MEANING OF OLIGOPOLY COMPETITION

Oligopoly refers to a market situation where the industry is dominated by a few large sellers.
Characteristic features of oligopoly are:
1. Few large sellers: There are few large sellers and each seller has substantial control oversupply and
prices.
2. Product may be homogenous or differentiated: For instance, cement is a homogenous product which
has a oligopolistic structure. On the other hand, the smartphone segment has highly differentiated
products.
3. Interdependence: The sellers are highly interdependent on each other for setting the price. For
instance, if a seller would resort to price-cutting, there will be an all-out price war and it would result
in suicide for the industry. On the other hand, if a seller were to increase the prices, no one elsewill
follow and he will go alone. As a result, he would end up losing all his customers to competitors.
4. Price rigidity and indeterminateness of demand curve: Due to price interdependence, there will
be sticky prices – i.e. prices tend to remain constant. Only if there is a substantial increase in factor
costs, then the entire industry will revise the prices.
5. Barriers to entry based on:
a. Control of supply of raw materials: Diamond mines in South Africa
b. Patents or copyrights: Microsoft for office products
c. Economies of scale: Amazon crushing all other sellers
d. Govt. franchise: Railways
6. Group behavior: All the firms of different sizes tend to behave like a loosely aligned group in
determining output and prices. It can result in the formation of cartels to informal pricing lobbies.

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12.2.1 Types of Oligopoly

Four major types of oligopoly are:
1. Pure or perfect oligopoly: In this type of oligopoly, firms produce homogeneous products. Bulk
industries such as cement, steel, aluminum and chemicals are examples of pure oligopoly.
2. Imperfect or differentiated oligopoly: In this type of oligopoly, firms produce differentiated products.
For instance, passenger cars, cigarettes or soft drinks. These goods are highly differentiated, yet
they are close substitutes of each other.
3. Collusive oligopoly: In this type of oligopoly, firms cooperate with each other in determining price
or output or both.
4. Non-collusive oligopoly: In this type of oligopoly, firms compete with each other.

12.2.2 Models of Oligopoly

The two major models of oligopoly include Cournot model and Bertrand model.
Cournot Model
This model was proposed by Augustin Cournot. It is based on behavioral assumptions. Firms maximise
profits under the assumption that market rivals will not change their rates of production.
Example
 There are two firms (duopoly) producing identical products
 Marginal cost is zero
 Initially, Firm A has a monopoly and then Firm B enters the market
Adjustment process
 Entry by Firm B reduces the demand for Firm A’s product
 Firm A reacts by reducing output, which increases demand for Firm B’s product
 Firm B reacts by increasing output, which reduces demand for Firm A’s product
 Firm A then reduces output further. This continues until equilibrium is attained
Under equilibrium:
 Firms are maximising profits simultaneously
 The market is shared equally among the firms
 Price is above the competitive equilibrium and below the monopoly equilibrium

Bertrand Model
Firms assume that their market rivals will not change their prices.

12.3 COLLUSIVE AND NON-COLLUSIVE MODEL – SWEEZY’S KINKED DEMAND CURVE

MODEL AND PRICE LEADERSHIP

Non-Collusive Model - Paul Sweezy’s Kinked Demand Curve Model

Sweezy used the Kinky demand curve to explain price rigidity or sticky prices. In an oligopoly situation,
firms largely prefer to keep the prices unchanged. This is because if one firm tries to reduce the price,

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all other firms will follow and it leads to a price war. This is suicidal for the industry. On the other hand,
if one firm tries to increase the price without any parallel increase in costs, then it will go alone. No
other firms will follow and it will lose all its customers to its rivals. Therefore, prices tend to be sticky
or indeterminate under an oligopoly market situation. This leads to a kink in the demand curve which
indicates sticky prices. Due to the rivals response, firms will try not to move away from the kink.
In the following diagram, we are illustrating the firm demand curve dd and the industry demand curve
is represented by DD. At the point of intersection of firm demand curve and industry demand curve E, the
equilibrium price OP is determined. At the point of intersection there is a kink at point E, so that the
relevant demand curve is dED. If the firm tries to reduce the price below OP, its rivals will retaliate and it
will result in an outright price war, and hence the firm’s gains will be netted away and its market share
will remain constant.
On the other hand, if it tries to raise the price above OP, it will go alone and no other firms will follow.
As a result, it will lose its entire market share to its rivals. Therefore, prices tend to be sticky at the kink
at OP levels.
Revenue

O Quantity Demanded
and Supplied

Figure 1: Kink in Kinky Demand Curve

Let us now look at how prices and output are determined under the kinky demand curve model. In Figure
2, the exact replica of the kinky demand curve studied above is represented. The upper part of the curve
has higher price elasticity than the lower part. Due to the kink in the demand curve, there is a
discontinuous gap in the MR curve. The MR curve below has two parts: part dA corresponding to the
upper part of the demand curve dE and BMR corresponding to the lower part of the demand curve ED.
In Figure 1, equilibrium is determined at the point of the kink because at any point to the left of the
kink, MC>MR. Thus, profits are maximised at the point of the kink. However, in this model equilibrium
is not necessarily defined at the point where MR = MC. Mostly, MC passes somewhere through the
discontinuous gap section AB of the MR curve. So long as MC passes through the AB segment, the firm
maximises profits by producing OQ output at OP price. This indicates that there is a range within which
marginal cost curves can change without impacting the equilibrium prices or output. The kink explains
why prices and output will not change even if costs change within the range of AB. For instance MC can
increase or decrease as MC1, MC2, or MC3, but prices will be fixed at OP. Greater the differences in the
elasticity of the upper segment and lower segment of the demand curve, wider will be the discontinuity
in the MR curve. Therefore, a wide range of cost conditions compatible with OP price and OQ output are

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possible. It is only when costs rise in general affecting, the entire industry prices will be revised upward
for all the firms. Since, there is a general rise in costs of production.

Revenue
E MC1

Figure 2: Price and Output Determination under Kinky Demand Curve Model of Oligopoly

Collusive Model – Price Leadership

The non-collusive oligopoly model (Sweezy’s model) presented in the earlier section is based on the
assumption that oligopoly firms act independently even though they are interdependent. Therefore,
an aggressive price competition may result in uncertainty. Thus, how can oligopoly firms remove
uncertainty? Firms do this by entering into pricing agreements with each other. Such agreements may be
both explicit (formal) or implicit (informal). This is called collusion.
In the oligopolist, a few powerful firms emerge which cannot be eliminated easily by the other powerful
firms. Under such circumstances, some of these firms collude with each other to gain maximum leverage.
Important forms of collusion include price leadership cartel and merger and acquisition. Many times
in the real world, a formal collusive agreement is not possible due to the fear of regulatory scrutiny.
In such cases, oligopolists sometimes operate through informal tacit collusive agreements. One of the
most common form of such informal collusion is price leadership. Price leadership arises when one
firm—which may either be a large or dominant firm—emerges as the price leader and initiates price
changes which other firms follow.
Collusion refers to cooperation among firms to restrict competition in order to increase profits. There
are two types of cartels:
a. Market-Sharing Cartel = Collusion to divide market share
b. Centralised Cartel
Centralised Cartel - Formal agreement among member firms to set a monopoly price and restrict
output. Here there is a strong incentive to cheat.
Let us now study the centralised cartel model.
In the below graph, in the industry quadrant, D is the market demand curve ad MR is the corresponding
MR curve for the two firms. The ∑MC is obtained by horizontally summing the MC curves of the two firms.
The centralised cartel will set the price as ` 8 and Q = 50 (at point E) where MR = ∑MC. Now the question
is how will market be shared between the two firms? Assume that firm 1 sells 20 units at a profit of ` 1
per unit (` 8 – 7) and earns ` 20 (Q20  ` 1 profit) in total (shown as shaded area). Firm 2 sells 30 units at a
profit of ` 2 unit (` 8 – ` 6) then it earns ` 60 in total. We have the solution for the monopolyfirm.

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That is the cartel sells 50 units of output an earns ` 80 in profit.

Firm 2 Industry (Cartel)

Price of X

Price of X

Price of X
MC1

ATC1 ATC2
F F
MC

Figure 3: Price and Output Determination under Centralised Cartel Model

Price Leadership
How does price leadership arise?
 It arises due to implicit collusion.
 The price leader acts as the barometric firm.
 The price leader is usually the largest, or dominant, or lowest cost firm in the industry.
 The demand curve is defined as the market demand curve less supply by the followers.
 Followers take market price as given and behave as perfect competitors.

Let us study the following diagram to understand the concept of price leadership. ABCFG is the market
demand curve for the product. ∑MC is the marginal cost curve of all the followers.
Price of X

DL

20 60 80 100

Figure 4: Price and Output Determination under Price Leadership Model

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Since followers always produce at the point where P=∑MCf,

Dt (total demand) - ∑MCf =Dl (demand curve of the leader). That is the HNFG area on the demand curve
faced by the dominant firm and MRl is the corresponding marginal revenue curve.
MCl is the MC of the leader. The leader will set price at ` 6 given by point N where MCl = MRl, where
profits are maximised. At this price leader’s output is 20 units. 60 – 20 = 40 is the remaining output
produced by followers. This is shown by point R.
This implies that at P = ` 6, the followers will supply 40 units of output and leader supplies 20 units. Total
market supply is 60 units.

Conclusion 12.4 CONCLUSION

 Under oligopoly, there are few large sellers and each seller has substantial control over supply and
prices.
 The sellers are highly interdependent on each other for setting price. For instance, if a seller would
resort to price-cutting, there will be an all out price war and it would result in suicide for the industry.
On the other hand, if a seller were to increase the prices, no one else will follow and he will go alone.
As a result he would end up losing all his customers to competitors.
 Price rigidity and indeterminateness of demand curve – due to price interdependence, there will be
sticky prices – prices tend to remain constant. Only if there is a substantial increase in factor costs,
then the entire industry will revise the prices.
 Sweezy used the Kinky demand curve to explain price rigidity or sticky prices. In an oligopoly
situation, firms largely prefer to keep the prices unchanged. This is because if one firm tries to reduce
the price, all other firms will follow and it leads to a price war. This is suicidal for the industry.On the
other hand, if one firm tries to increase the price without any parallel increase in costs, thenit will
go alone. No other firms will follow and it will lose all its customers to its rivals. Therefore, prices
tend to be sticky or indeterminate under oligopoly market situation. This leads to a kink inthe
demand curve which indicates sticky prices. Due to the rivals response firms will try not to moveaway
from the kink.
 Collusion refers to cooperation among firms to restrict competition in order to increase profits. There
are two types of cartels: Market-sharing Cartel – Collusion to divide market share and centralised
cartel
 Price leadership arises due to implicit collusion. The price leader acts as the barometric firm. The
price leader is usually the largest, or dominant, or lowest cost firm in the industry. The demand curve
is defined as the market demand curve less supply by the followers. Followers take market price as
given and behave as perfect competitors.

12.5 GLOSSARY

 Cartel: The cooperation among firms to restrict competition in order to increase profits
 Priced leadership: The largest, dominant, or lowest cost firm in the industry emerges as the price
leaders
 Herfindahl Index (H): The index denoted by H, where H = Sum of the squared market shares of all
firms in an industry

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12.6 CASE STUDY: CEMENT INDUSTRY – A PROFILE

Case Objective
This case study highlights the formation of cement cartel in India and the anti-cartel action taken by
the CCI.
India is the world’s 2nd largest cement market, both in production and consumption. It is bolstered by the
high level of demand from real estate and increased government spending on smart cities and urban
infrastructure.
In 2017-18, cement production capacity was 455 MTPA. The industry was projected to grow at 5-6%
between FY17-20. However, due to a gross mismatch in supply and demand over the period 2007-17, there
was poor capacity utilisation of less than 70%. Consequently, the sector’s growth remained stunted with
a lower growth trajectory. Going forward, cement consumption is expected to grow by 4.5 percent in
FY19 supported by pick-up in the housing segment and higher infrastructure spending.
Housing is one of the biggest sources of cement demand in India at 65% and hence this is the biggest
demand driver. Housing has been growing at a steady modest pace even during the lean period.
However, it is the demand from infrastructure sector which impacts its growth.
For the purpose of marketing, the entire country has been divided into five regions: North, South, East,
West and Central. A few companies dominate in each of these zones. Only 40 large companies account for
97% of the installed capacity. 21 companies control 90% market share. Further, just two companies,
Holcim and Aditya Birla Group control 40% market share. This is a clear case of oligopoly competition.

Competition Commission of India

In 2003, the Competition Commission of India was set up under the Competition Act, 2002, overthrowing
the MRPT Act. The major objective of CCI is to eliminate practices that have an adverse effect on
competition in the market and to promote and sustain a healthy competitive environment. The
Competition Commission of India chief objective is to ensure that consumers have access to a wide range
of goods and services at the most competitive prices.
Competition is a critical element of market because only if competition exists, producers have maximum
incentive to innovate and specialise which in return will result in reduction in price and wide variety
of products for the consumers to choose. CCI aims to create and sustain such fair competition in the
economy that will bring up a ‘level playing field’ to the producers and make the markets work for
consumer welfare.
As part of its duties, CCI investigates Cartels as a means of anticompetitive behaviour adopted amongst
producers mostly of consumer goods. The Act empowers the commission in case of a cartel, to impose
upon such seller, distributor, trader or service provider included in the cartel, a penalty equivalent
to three times of the amount of the profit made out of such agreements by the cartel or 10% of the average
of the turnover of the cartel for the last preceding three financial years, whichever is higher.The
Commission under Article 27 of the Competition Act, 2002, may impose a penalty upto three times its
profit for each year that the prohibited agreement has been in effect; or 10% of its turnover for each year
that the prohibited agreement has been in effect, whichever is higher

Cement Industry – Evidence of a Cartel

The investigation into the cartel practices of the cement industry began when under the Section 19
of the Competition Act of 2002, the Builders’ Association of India (BAI) filed a complaint on 26th July,

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2010 against the Cement Manufacturer’s Association (CMA) and 11 other major cement manufacturing
companies for the alleged violation of the provisions of Section 3 and 4 of the Act (Case 29/2010 before
the competition Commission of India).
As per the complaint before the CCI, the respondent contends that cement manufacturers indulgedirectly
or indirectly into restrictive trade practices in an effort to control the price of cement by limiting the
production and indulge in collusive price fixing (underutilising capacity to increase AC and justify the
high prices). The complainant also argued that it is the strategy of the cement companies to divide the
territory of India into five zones so as to control supply and fix high prices.
Further, the top 11 companies which collectively hold more than 57% of the market share in India enjoy
a position of dominance and arbitrarily increase the price of cement. The complainant states that ACC
cements and Gujarat Ambuja Cements command approximately 21% market share in India. But with
effect from Nov 1st 2009, they have withdrawn their membership from the CMA.
However, inspite of having resigned from the membership, ACC and Gujarat Ambuja cement have
been successful in keeping their prices per bag similar to that of other cement manufactures. There is a
growing feeling in the industry that CMA indulges in cartelisation and holds up cement prices artificially
high. It was alleged that the main reason for Holcim Cements to leave CMA is because the company felt
being associated with CMA would get them in trouble with Competition commission in EU.
In fact, Holcim Group has a track record of being in violation of the laws of the land in many countries
that it operates. It had regulatory action taken against it for its anticompetitive practices all over the
world.
According to the BIA, CMA indulges in the following practices with a sole intention to control supply
produce less cement and increase the market price of cement deliberately.
 The large cement manufacturers have set up the cement manufacturing units at different places in
India keeping In view the availability of raw materials, power, coal, etc which results in differences in
costs of production.
 The Indian Cement Industry witnessed a phase of de-consolidation during 2008-14, when several
regional players added capacity to tap new demand. However, in 2014, with the exit of several
players, with stressed assets acquired by the larger players, the industry witnessed a steady phase
of consolidation. This is evidenced by the Herfindahl Hirschman Index which had the same
concentration score as in 2005-09. This created an opportunity for players to increase market power.
Further, the capacity share of the top 5 players stood steady at 57% over the period 2005-17.
 However, not only existing players are adding more capacity but new and more aggressive players
such as JSW Cement and Adani Cements are also increasing the output. This could either potentially
reduce the concentration of market power or result in new players replacing the old players, like it
happened in other industries.

CCI – Anti-Cartel Action

The Competition Commission of India (CCI) in June 2012 severely censured the cartelisation in the
cement industry. It imposed a penalty of at least ` 6,300 crore on the top 11 makers of cement in India.
Among these, the worst hit were ACC Ltd, Ambuja cements Ltd, Ultra Tech Cement Ltd and Jai Prakash
Associates Ltd which have all been fined in excess of ` 1000 crore each.
Even in the past the country’s anti-monopoly watchdog CCI (earlier MRTPC) has been issuing notices to
the top cement manufacturing companies after its investigative arm, Director General of Investigations
and Registrations (DGIR) had pointed towards cartelisation and condemned Cement Manufacturers
Association for the exorbitant increase in prices.

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In spite of repeated warnings by the Commission the price of cement in India has increased at astaggering
rate without any corresponding increase in the cost of inputs and increase in the number of players.

Cement prices – Latest Trends

Cement prices have continued to rise even after CCI action. At the latest in March 2021, cement prices have
gone up by ` 50 a bag this month, sparking anger among developers and builders, who claim it has been
done deliberately for profiteering. From ` 390 per bag it was increased to ` 440. The Builders Association
of India (BAI) is again at loggerheads with CMA over the price rise. The BAI and Confederation of Real
Estate Developers’ Associations of India (CREDAI) continue to urge the Prime Minister to form a Cement
Regulatory Authority (CRA) to curb cartelisation in the industry.

Questions
1. What kind of market structure does the Indian Cement Industry exhibit? Justify your answer by
applying the features of the market model to this industry.
(Hint: oligopoly)
2. What proxy indicators can be used from the case which will help us to indirectly assume cartelisation?
(Hint: market share, production, demand, supply, capacity utilisation, etc.)
3. Do you think that the CCI has been effective in controlling market power by levying unprecedented
fines on this industry? Do you think market power has remained the same or gone down or gone up?
Do you think that the policymakers have the willpower to dismantle cartels? Justify your answer
(Hint: no, the capacity share of the top 5 players stood steady at 57% over the period 2005-17. Prices
of cement have been increasing and BAI continues to complain about cartelisation)
4. What are the measures that you would suggest to the policymakers of this country to reduce the
extent of monopoly power in this market? Do you think it’s simply a case of “where there is a will
there is a way” or a much more deep-rooted problem of supply conditions determining input costs
and therefore prices?
(Hint: CCI should act impartially and decisively to take swift action, there is evidence that cement
prices have been deliberately increased without a parallel increase in price – all this point out to
cartelisation and govt. has been ineffective in curbing it so far).

12.7 SELF-ASSESSMENT QUESTIONS

A. Essay Type Questions

1. What is oligopoly? What are its characteristic features?
2. What is the implication of the kink in Sweezy’s Kinky Demand curve model? Why are prices sticky
at the kink? How does this influence, costs, output, prices and profit under oligopoly? Illustrate with
suitable diagram
3. How are prices and output determined in the centralised cartel? Illustrate with suitable diagram
4. What is meant by price leadership? How does the price leader set the price under oligopoly
competition? Illustrate with suitable diagram

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12.8 ANSWERS AND HINTS FOR SELF-ASSESSMENT QUESTIONS

A. Hints for Essay Type Questions

1. Oligopoly refers to a market situation where the industry is dominated by a few large sellers.
 Characteristic features of oligopoly: few large sellers, product may be homogenous or
differentiated, interdependence, etc. Refer to section Meaning of Oligopoly Competition
2. Sweezy used the Kinky demand curve to explain price rigidity or sticky prices. In an oligopoly
situation, firms largely prefer to keep the prices unchanged. This is because if one firm tries to reduce
the price, all other firms will follow and it leads to a price war. This is suicidal for the industry. On the
other hand, if one firm tries to increase the price without any parallel increase in costs, then it will go
alone. No other firms will follow and it will lose all its customers to its rivals. Therefore, pricestend to
be sticky or indeterminate under an oligopoly market situation. Refer to Section Collusive and Non-
Collusive Model – Sweezy’s Kinked Demand Curve Model and Price Leadership
3. Centralised Cartel is a formal agreement among member firms to set a monopoly price and restrict
output. Here there is a strong incentive to cheat. Refer to Section Collusive and Non-Collusive Model
– Sweezy’s Kinked Demand Curve Model and Price Leadership
4. Price Leadership arises due to implicit collusion. The price leader acts as the barometric firm. The
price leader is usually the largest, or dominant, or lowest cost firm in the industry. The demand curve
is defined as the market demand curve less supply by the followers. Followers take market price as
given and behave as perfect competitors. Refer to Section Collusive and Non-Collusive Model –
Sweezy’s Kinked Demand Curve Model and Price Leadership

@ 12.9 POST-UNIT READING MATERIAL

 https://www.economicsdiscussion.net/oligopoly/cartels-types-joint-profit-maximisation-and-
market-sharing-cartel/7370
 https://www.economicsdiscussion.net/oligopoly/price-leadership-under-oligopoly-with-
diagram/3778

12.10 TOPICS FOR DISCUSSION FORUMS

 Is oligopoly useful to society? Take the cement industry discussed in the case study as an example.

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