Managerial Economics

Assignment-2

Submitted To: - Dr Sudhanshu Bhushan

Submitted By: - Deepak Tolani
Roll no: - JKBS/AICTE/2021/012
Date Of Submission: - 30th October 2021
Oligopoly
Oligopoly is a market situation where there are few firms selling the products to large number
of buyers in the market producing either homogeneous or close substitute and every seller has
participable effect on other seller and firm is in position to influence the market. Oligopoly is
also known as limited competition, incomplete monopoly etc. Some examples of oligopoly
are Telecom Industry, Petroleum Industry, Steel Industry , Automobile Industry.

Features Of Oligopoly
1. Few Sellers: Under oligopoly market there are very few sellers, the number of sellers
are too small that each and every seller get effected by the activities of others. Each
firm has large portion of output in his hands so it posses a large degree of monopoly
power.
2. Interdependence: This is an important feature of oligopoly market of being
interdependent on each other due to small number of firms ,each firm contribute a
significant portion of total sale. As a result when any firm undertake sales promotion
measure, it directly effect other firm and immediately react. Every firm decides its
policy after taking into consideration the possible reaction of its rival firms.

3. Group Behaviour: Sometimes in oligopoly market firms enter into a collusion and
work as a group to earn maximum profits. When firms make group through mutual
agreement they would act as a independent units while firms are working
independently there is a price war.

4. Advertising expenses: It is generally observed that under oligopoly firms at the

place of price competition take non price competition in order to increase their sales
and profit . Under non Price competition firms utilize publicity , selling techniques
etc, which increase their expenditure on the same and ultimately burden of these
expenses falls on the customers.

5. Restricted entry and exit: One of the feature of the oligopoly is restricted entry and
exit because there is huge investment required to enter into the industry and if firms
have entered they will face a tough competition as the existing firm will have cost
advantage and loyal customers due to which new will face various problems and
would be forced to leave the market.
Price output determination under oligopoly
One of the characteristics of oligopoly market is price and output determination is
indeterminant, the feature of interdependence of one firm on another under oligopoly market
makes derivation of demand curve a difficult proportion. That’s why price and output
determination under oligopoly is said to be indeterminant. However, price and output are said
to be determined under collusive oligopoly. But there too collusion may not last or it may
break down. A different view of oligopoly is that price under oligopoly is sticky i.e., price
once determined tends to be stable.

There are various models with the help of which price can be determined under oligopoly:

A. Kinked Demand curve Model: This demand curve model was given by Paul M
Sweezy in the year 1939. This model does not deal with price-output determination
but it seeks to establish that once a price quantity combination has been determined
an oligopoly firm will not find it beneficial to change its price even when the cost and
demand conditions change. It refers to a state of price rigidity. The reason behind this
is as follows- If a firm reduce the price of it’s product the other firm will also reduce
the price on the other hand if a firm increase the price of its products the other firm
will either maintain the price as it was or it could also cut their prices down. In both
the case the firm tends to loose a part of its market share. This assumption is made by
all the firms in respect of other oligopoly firms. Therefore the firms find it beneficial
to maintain its price and output at existing level.
To understand the kinked demand curve analysis more closely let see the action and
reaction of the rival firm to the price change made by one of the firm. There are 3
possible ways in which rival firm may react to the change in price made by one firm.-
1 The rival firms follow both the price cut as well as price hike.
2 The rival firm don’t react to price change.
3 The rival firm follow the price cut but not price hike.
Two slope of firm demand curve or kinked
demand curve
The demand curve of firm will have two different slopes.
1 Since any price rise by an individual firm is not followed by other firms, this firm
will loose its share of the market and demand will fall considerably. Hence the AR
Curve or demand curve of the firm (which raise the price ) will be flatter at the upper
stretch of the demand or Average revenue curve
2 Any cut in price of the product by an individual firm is followed by rival firm which
also reduced the price of their products. Thus the firm fails to expand market.
Hence ,the average revenue or the demand curve of the first firm will be relatively
steep at the lower stretch.
When an individual firm’s demand curve or Average revenue curve has two different
slopes-Flatter at upper stretch (more elastic) of the curve and steep at lower stretch a
 kink is bound to occur in the demand or average revenue curve of the firm shown in
figure

1 In the figure kinked demand curve is made of two demand curve AB and BD both
of these join at point B . Point B is the point of kink in this diagram
2 The kink B is at the ruling price OP , AB portion of the demand curve is more
elastic , showing that oligopolist will loose his customer if they raise price
3 BD portion of demand curve is less elastic showing that he cannot increase the sales
by reducing price.
4 The marginal revenue curve corresponding to this kinked demand curve is
composed of two discontinuous dotted lined segment. The AS portion of demand of
the MR curve relates to the demand curve AB and TMR portion relates to demand
curve BD.
5 The equilibrium of the firm will be at the point where MR is equal to MC. The firm
will be in equilibrium at output OQ and price will be BQ (=OP) At this point firm
enjoys maximum profit.
6 If the cost of production changes it will give rise to new MC1 and MC2 curve. As
there is discontinuity in MR curve , shift in MC curve between S and T will not alter
the equilibrium position. Thus it can be viewed that under oligopoly ,despite change
in cost and demand , the price remained unchanged or rigid.

B. Collusion Model-The Cartel

In oligopolistic market situations, There is high competition among the firms, which may
lead to price war. For avoiding such type of problems, firms enter into an agreement
regarding uniform price-output policy. This agreement is known as collusion, which is
opposite to competition. Under collusion, firms are involved in collaboration with each other
to take combined actions for keeping their bargaining power stronger against consumers.

Collusion helps oligopolistic firms in many ways.

Some of the advantages of collusion are as follows:

i. Helps firms to increase their effectiveness and efficiency.
ii. Helps firms in preventing uncertainties

iii. Provides opportunities to prevent entry of new firms

The agreement of collusion may be tacit or formal in nature. Formal agreement is between a
rival firms which is known as cartel. so, cartel refer to group of firms that together make
price and output decision.

Under cartels, the price and output determination is made by the common administrative
authority, which aims to distribute equal profit among all member of the organizations under
cartel. The total profits are distributed in proportion as decided by member of the
organizations. One of the world famous example of cartel is Organization of the Petroleum
Exporting Countries (OPEC), which has shared control of petroleum markets.

Let us understand price and output decisions under cartels with the help of an example.
Assume that there are two organizations that have formed a cartel .It can be explained with
the help of figure

In Figure , AR is the aggregate demand curve of both the organizations and MC curves are
the addition of MC1 and MC2 curves of firms A and B, respectively. The total output of the
industry is determined according to MC and MR of the industry. In Figure OQ and OP are the
equilibrium price and output of the industry.

Now, this output will be allocated among the firms. This can be done by drawing a horizontal
line from equilibrium point E of industry, towards MC curves of organizations A and B. The
points of intersection E1 and E2 are the equilibrium levels of the organizations, A and B,
respectively. OQ1 is the equilibrium output of organization A and OQ2 is the equilibrium
output of organization B. Thus, OQ1 + OQ2 = OQ. These levels of outputs ensure the
maximum joint profits of member Firms.
C Price leadership model

An important form of price fixation under oligopoly is known as price leadership. It refers to
a market situation in which price is determined by one firm of the industry which other firm
in the industry accept.

Types of Price Leadership

There are basically three primary models of price leadership: barometric, collusive, and
dominant.

Barometric

In the barometric price leadership an old experienced firm not necessarily dominant one
assumes the role of leader and fixes the price acceptable by all the firm in the industry .the
price change announced by the leader serves as barometer that reflect the changing demand
and supply condition in the market .the barometric price leader does not act to impose its
decision on other but rather indicates change that seems desirable in the market.

In order to fix the price this experienced firm take into consideration demand of the product ,
cost of production ,competition from rival producer etc. The leader while fixing price does
not look into its own interest rather it considered the interest of all the firm in the industry. As
leader protects the interest of all the firm in the industry, all firms happily follow the price
leader.

Collusive

The collusive charge management version can also additionally emerge inside markets which
have oligopolistic situations. Collusive charge management takes place because of an specific
or implicit settlement amongst a handful of dominant companies to hold their fees in mutual
alignment. Smaller companies withinside the marketplace are efficiently pressured into
following the charge alternate initiated with the aid of using the dominant companies. This
exercise is maximum not unusual place in industries in which the price of access is excessive,
and the expenses of manufacturing are known. These agreements among companies–both
specific or implicit–can be taken into consideration unlawful if the attempt is designed to
defraud the public. There is a pleasant line among charge management and unlawful acts of
collusion. Price management is much more likely to be taken into consideration collusive–
and probably unlawful–if the modifications withinside the charge of a terrific aren't
associated with modifications withinside the working expenses of the company.

Dominant

In dominant price leadership model one firm produce the major portion of output of thre
industry , the other firm produce together the balance output of the industry. None of the
small firm produce enough to have any determinant effect on the price. As a result the
dominant firm fix the price and other firm accept it.

If the small firm charge price more than the price fixed by the leader they tend to loose all
their shares. That’s why the Average revenue curve for the follower firm is horizontal line
parallel to x axis. They are required to adjust their output to the point at which their marginal
cost is equal to price determined by dominant firm .
Generally prices are uniform if the products are homogeneous if the products are
differentiated prices can be uniform to a given pattern of differentials. The price leader make
changes from time to time .The small firms follow leader believing that profit will be greater
in the long run under price leadership that could be obtained under alternative price
arrangements.

Conclusion
By doing this assignment I come to a conclusion that price output determination is strategic
in this market as when one firm follow price cut the other firms also follow it so that don’t
loose their market share similarly if other firm increase price in this market the other firms
don’t follow it as they want to get the market share of other firm by keeping their price
constant, due to interdependence of one firm on another the firm decide their pricing strategy
by keeping in mind what could be reaction of its competitor.