MANAGERIAL ECONOMICS

Oligopoly and Cartels

Biplab Sarkar
Department of Management Studies
MANAGERIAL ECONOMICS

Oligopoly and Cartels

Biplab Sarkar
Department of Management Studies
MANAGERIAL ECONOMICS
Oligopoly

✓ An oligopoly is a market with only a few firms and with

substantial barriers to entry, which prevent other firms
from entering.
✓ Example: Nintendo, Microsoft, and Sony are oligopolistic
firms that dominate the video game market. Only a
handful of firms control the automobile, television, and
aircraft manufacturing markets.
MANAGERIAL ECONOMICS
Characteristics of the Oligopoly Market

Recognised interdependence among the sellers

Spend much on advertisement

Oligopoly Market

Presence of competition

Lack of uniformity in the size of firms

Barriers to entry of firms

MANAGERIAL ECONOMICS
Price Determination Under Oligopoly

PRICE AND OUTPUT DETERMINATION UNDER OLIGOPOLY:

Generally the firm is in equilibrium position where its marginal cost curves equals its marginal rev-enue
curves and price is depicted with the help of average revenue curve or demand cure. But this analysis is not true
in the case of oligopolistic situation because of the interdependence of the firms and indetermi-nateness of the
demand curve and considerable distinction in the allocation of common cost to specific products, with the result
that there is no single definite cost curve. Price and output determination can be studied under the following three
situations:
A. Independent pricing
B. Pricing under collusion
C. Pricing under Price Leadership.
MANAGERIAL ECONOMICS
Price Determination Under Oligopoly

A. Independent Pricing: Under oligopolistic market situation each firm tries to follow
an independent price and output policy. The price fixed by each firm may be more or
less than monopoly price, because each firm produces a differentiated product. And on
the basis of fixing the prices in a competitive manner, the price war breaks out
between the firms. Thus, there can be two limits; the upper limit laid down by the
monopoly price and the lower limit is determined by the actual price which may come
to be fixed under oligopolistic conditions. There is no simple theory that explains
where the actual price will be set between these limits which further depends on the
circumstances and conditions prevailing in the market. In case where the firms are
producing similar products and all the firms in existence are showing the market
proportionately and equally, then a uniform pricing policy is to be fixed by them. But
in case of differenti-ated products as discussed earlier each oligopolistic firm is in
such a position as to fix the price like a monopolist.
MANAGERIAL ECONOMICS
Price Determination Under Oligopoly

But some modern economists say that free price policy is not found in the real situation because
of the wrong assumptions like identical products, iso-cost, equal and proportionate distribution of
market etc. So, under oligopoly the price does not remain stable. The economists are of the view
that behaviour of an oligopolistic market is indeterminate. What they mean is that its behaviour
cannot be explained by the same conceptual apparatus that applies to other market structures. The
independent pricing under oligopolistic market leads to lot of uncertainty, insecurity and antagonism
in the market. It is because of this uncertainty, insecurity and antagonism some economists points
out that independent price setting under oligopoly cannot remain for a longer period and it will
further be replaced by other forms of price fixation. Thus, on the basis of uncertainty, insecurity
and antagonism independent pricing is not possible under oligopolistic market structure
which leads to price war and price rigidity.
MANAGERIAL ECONOMICS
Price Determination Under Oligopoly

Price War : Price war sets in when a firm reduces the price of its product in order
to increase its sales and maximise revenue. Its rival firms also resort to cutting down the
price of its product so each firm tries to undercut the other which paves way to price
war as can be well depicted in the diagram.

To explain the price war we take two firm A & B with their respective reaction
curve Ra and Rb as the price line. The firm A & B whose price moves are taken along
X-axis and Y-axis respectively as shown in diagram with Ra and Rb respective reactive
reaction curves. The curve R focuses the price reaction of firm A and Rb is the reaction
curve of firm B. The curve Ra focuses the price reaction of firm A to the price move of
firm B, similarly, Rb shows the price reaction of B to the price move of A. Suppose,
initially the firm A changes price equal to OA then firm B reacts and cuts its price to
OB1 from OB; Further A reacts and charges a price equal to QA1 and B will react to
this decline in A's price and B charges a price equal to OB2. This price reduction turns
into price war and will continue until both reach at point E where A - firm charges price
equal to OA3 and B charges price equal to OB3 and further price cutting will be
disastrous for both firm. A and firm B.

Thus a position of stable equilibrium is not to be found under oligopolistic

market due to the presence of uncertainty, insecurity and antagonism.
MANAGERIAL ECONOMICS
Price Determination Under Oligopoly

B. PERFECT COLLUSION UNDER OLIGOPOLY:

A collusion or a cartel is a combination of firms whose object is to limit the scope
of competitive forces within a market. Individual firms of a certain industry surrender to
a central association the power to make price and output decisions. Thus, the cartel or
collusive oligopoly assumes monopoly power the determines the price and output in the
same capacity with zeal and jest. Perfect collusion implies cartel agreements which is an
association of the independent firms within the industry. Perfect cartel under oligopoly
with complete control over the price and output policy of the member firms and with the
threat of entry is a situation for consideration.
MANAGERIAL ECONOMICS
Price Determination Under Oligopoly

1. Perfect collusion: Perfect cartel is an extreme form of perfect collusion. Each firm reserves profits according to
the assigned quota and therefore the principle of cost maximization is not likely to be followed. Thus, it is also
contemplated that price and output results obtained under perfect collusive oligopoly are the same as obtained
under monopoly. The price and output under central can be illustrated with the help of following diagram
MANAGERIAL ECONOMICS
Price Determination Under Oligopoly

In diagram DD is the industry demand curve and MR is the corresponding marginal revenue curve taking
three oligopolistic firms A, B and C in the industry. Their marginal cost curves are MC1, MC2 and MC3
respectively with OP1 level of price with their respective output equal to OQ1m OQ2 and OQ3. MC is the
lateral summation of the marginal cost curves of all the individual firm in the industry which equals Marginal
revenue curve at point E with OQ level of output with the price level OP, as DD is the demand curve for the
industry and also determines the price for the industry as a whole under the conditions of perfect collusion and
each firm will produce that level of output at which marginal cost curves equals industry's marginal revenue
curves i.e. EP1.

Thus A will produce OQ1, B will produce OQ2 and C will produce OQ3 of the output and OQ being the
total output of the industry (OQ1+OQ2+OQ3 = OQ). It results into the maximum joint profit for the industry but
it is not necessary that each firm may have profit equal to their quota allotment. Mutual agreement and relative
bargaining power determine the division of profit.
MANAGERIAL ECONOMICS
Price Determination Under Oligopoly

2. Market Sharing Cartel under Oligopoly:

Another form of perfect collusion under oligopolistic market is that of market sharing cartel by the member firms of a cartel. Market
sharing cartel is an equal division of total market sales among all its firms. In differentiated oligopoly all firms in an industry enter into a
collusion for charging a uniform price which is agreeable to all the firms. They divide the market among themselves according to an
agreement and get profits according to its sales and their demand curve will be a part of the demand curve for the industry. As each firm has
its own demand curve with the same elasticity as that of industry demand curve which can be illustrated in diagram.
MANAGERIAL ECONOMICS
Price Determination Under Oligopoly

When equal market's sharing DD is the industry demand curve and MR is the corresponding marginal revenue curve
(DD1) MC is the aggregate marginal cost curve of the industry. MR curve DD1 intersects MC curve at point E and
set OP price and OQ level of output under this situation. Industry output OQ is shared equally by the firms at MC
curve of firms cuts MR curve at point C and OQ level of output is determined as OQ level of output is for the
industry as a whole. Thus, OQ is just half of the total output QO or OQ0 - QoQ level of output. Thus, equal level of
output is shared by the firms. Each firm tries to increase the share of the market by means of secret price concessions
which tends to change the demand cost conditions further and price variations among firms become more common
and ultimately the agreement becomes a farce and all the firms act independent oligopolists.
MANAGERIAL ECONOMICS
Price Determination Under Oligopoly

C. PRICE LEADERSHIP:
Price leadership is imperfect collusion among the oligopolistic firms in an industry with the dominant firm as all firms follow the
dominant firm as one of the big firm in an oligopolistic market. There is an agreement among all the firms to sell the product at a
price set by the leader of the dominant firm in an industry. Sometimes a meeting is held and a definite agreement is taken by the
dominant firm. In case of homogeneous or heterogeneous product the price may be a uniform price and the same is announced by the
leader of the firms for example, price leadership industries are like cement, cigarettes, flour, fertilizers, petroleum, milk, steel, etc.
Price leadership may be of different types.
(i) There is a barometric price in which there is no dominant firm which announces the price but the wisest firm announces the
price by taking into consideration the demand and cost conditions and the rest follow suit.
(ii) When the price is announced by a dominant firm then it is known as dominant price leadership. It is also known as partial
monopolistic price leadership.
(iii) The dominating firm may fix the profit maximisation price for itself and for the others to accept it; it is known as aggressive
price leadership. It may fix such a low price as some ofthe firms may resort to exit from the industry.
(iv) When the pricing is done by the dominant firm suppressing competition among oligopoly firms is known as effective price

leadership.
THANK YOU

Biplab Sarkar
Department of Management Studies
biplabsarkar@pes.edu
+91 80 6666 3333 Extn 337