Chapter VI : Oligopoly

Meaning of Oligopoly

Oligopoly is a market situation in which there are a few firms sellinghomogeneous or

differentiated products. It is difficult to pinpoint the number offirms in the oligopolist
market. There may be three” four of five firms. It is alsoknown as competition among
the few. With only a few firms in the market, theaction of one firm is likely to affect
the others. An oligopoly industry produceseither a homogeneous product or
heterogeneous products. The former is calledpure or perfect oligopoly and the latter
is called imperfect or differentiatedoligopoly. Pure oligopoly is found primarily
among producers of aluminium,cement, copper, steel, electricity, etc. Differentiated
oligopoly is found amongproducers of such consumer goods as automobiles,
cigarettes, soaps &detergents, TVs, rubber types, refrigerators, etc.

Definition of Oligopoly-

“Oligopoly is defined as a market structure with a small number of firms, none of which
can keep the others from having significant influence”.

Characteristics of Oligopoly
In addition to fewness of sellers, most oligopolistic industries haveseveral common
characteristics which are explained below.
(1) Interdependence :
There is recognized interdependence among thesellers in the oligopolistic
market. Each oligopolist rum knows that changes inits price, advertising, products
characteristics, etc. may lead to countermoves byrivals. When the sellers are few,
each produces a considerable fraction of thetotal output of the industry and can have
a noticeable effect on marketconditions. He can reduce or increase the price for the
whole oligopolist marketby selling more quantity or less and affect the profits of the
other sellers. Eachseller has direct and ascertainable influence upon every other seller
in theindustry. Thus, every move by one seller leads to countermoves by the others.

(2) Advertisement :
The main reason for this mutual interdependence indecision making is that one
producer’s fortunes are dependent on the policiesand fortunes of the other producers
in the industry. It is for this reason thatoligopolist firms spend much on advertisement
and customer services. Forexample, if all oligopolists continue to spend a lot on
advertising their productsand one seller does not match up with them, he will find his
customersgradually going in for his rival’s product. If, on the other hand, one
o.1igopolistadvertises his product, others have to follow him to keep up their sales.

(3) Competition :
This leads to another feature of the oligopolistic market,the presence of competition.
Since under oligopoly, there are a few sellers, amove by one seller immediately
affects the rivals. So each seller is always onthe alert and keeps a close watch over
the moves of its rivals in order to have acounter move. This leads to intense
competition on the basis of advertisementquality improvement, cost reduction, better
service / delivery etc.

(4) Barriers to Entry of Firms :

As there is keen competition in anoligopolistic industry, there are no barriers to
entry into or exit from it in legalsense. However, in the long-run, there are some other
types of barriers to entrywhich tend to restrain new firms from entering the industry.
They may be : (a)economies of scale enjoyed by a few large firms; (b) control over
essential andspecialized inputs; (c:) high capital requirements due to plant costs,
advertisingcosts, etc. (d) exclusive patents; and licenses; (e) government policy i.e.
licence,permit and the other control measures. When entry is restricted or blocked
bysuch natural and/or artificial barriers the oligopolistic industry can earn
longrunsupernormal profits.

(5) Indeterminate Demand Curve :

It is not easy to trace the demandcurve for the product of an oligopolist. Since
under oligopoly the exactbehaviour pattern of a producer cannot be ascertained with
certainty, hisdemand curve cannot be drawn accurately and with definiteness. How
does anindividual seller’s demand curve look like in oligopoly is most
uncertainbecause a seller’s price or output moves led to unpredictable reactions on
priceoutput policies of his rivals, which may have further repercussions on his
priceand output. The chain of action reaction as a result of an initial change in priceor
output is all a guess-work.

Price Determination Under Oligopoly

With these characteristics of oligopoly in the background, we study thedetermination
of prices and outputs by oligopolistic firms. Prof. Machlup has
given a detailed classification of oligopolies. But we shall confine our study to
the non-collusive oligopoly model of Sweezy (the kinked demand curve) and to
the collusive oligopoly models relating to cartels and price leadership.
I. Non-collusive Oligopoly
1. The Sweezy Model of Kinked Demand Curve
In his article published in 1939, Prof. P.A. Sweezy presented the kinkeddemand
curve analysis to explain price rigidities often observed in oligopolisticmarkets.
Sweezy assumes that if the oligopolistic firm lowers its price, its rivalswill react by
matching that price cut in order to avoid losing their customers.Thus the firm
lowering the price will not be able to increase its demand much.This portion of its
demand curve is relatively inelastic. On the other hand, if theoligopolistic firm
increases its price, its rivals will not follow it and raise their
prices. Thus the quantity demanded of this firm will fall considerably. This
portion of the demand curve is relatively elastic. In these two situations, the
demand curve of the oligopolistic firm has a kink at the prevailing market price
which explains price rigidity.

Its Assumptions
(i) There are few firms in the oligopolistic industry.
(ii) The product is of the same quality.
(iii) There is an established or prevailing market price for the product atwhich all the
sellers are satisfied.
(iv) Any attempt on the part of a seller to push up his sales by reducing theprice of his
product will be counteracted by other sellers who will followhis move. If he raises
the price others will not follow him, rather theywill stick to the prevailing price and
cater to the customers, leaving theprice-raising seller alone.
(v) The marginal cost curve passes through the dotted portion of themarginal revenue
curve so that changes in marginal cost do not affectoutput and price.

The Model
Given these assumptions, the price-output relationship in the oligopolistmarket is
explained in Figure (10.3) where KPD is the kinked demand curveand OP0 is the
prevailing price in the oligopoly market for the OR product ofone seller. Starting
from point P1 corresponding to the current price OP0, anyincrease in price above it
will considerably reduce his sales, as his rivals are notexpected to follow his price
increase. This is so because the KP portion of thekinked demand curve is elastic, and
the corresponding portion KA of the MRcurve is positive. Therefore, any price
increase will not only reduce his totalsales but also his total revenue and profit.